Written by Charles   

We use many things in our daily lives and, for the most part, we know what the things are AND we know how we can use them. And we don't confuse what we use them for with what they are. For example, a cell phone: We know it is made from metal, plastic and has electronics in it and that it uses radio waves from a tower someplace; that is what it is but we use it to talk to people (and sometimes computers these days) who are far away from us. It is the same with a car; it is made of metal, plastic, rubber and wires; it needs a battery and we have to pump in fuel but we use it to go from point "A" to point "B" if there is a passable road between the two points. What a thing is and what we use it for are two totally different things. But, unfortunately for us individually and perhaps our society as a whole, there is one thing we use on a daily bases with which we have troubles conceptualizing the difference between what it is and how we use it. Money. We are taught from the time we are toddlers what we can do with money. Ask anyone out of the blue "Do you know what money is?" and they will probably smile and say "Of course." But then press them with "Well, what is money?" and they might frown, think a little and then respond, "Well, you can buy stuff and pay bills with money." Right. That is how you use it. Now, what is this money, totally divorced from how you can use it? That's a much harder question .

Many noteworthy people have commented on this basic ignorance about what money really is. Henry Ford made a famous comment concerning money. He said: “It is well enough that people of the nation do not understand our banking and money system, for if they did, I believe there would be a revolution before tomorrow morning.” My intention is not to instigate a revolution but I do want to do my part to inform. I agree with the observation of another wise but controversial person, Ezra Pound, who opined that the social consequences of the world population fully understanding money would compare with the experienced consequences of the world population generally becoming literate, which were, as we know, truly enormous.
The literature is replete with good articles and books on money, what it is and what is wrong with our current monetary system. These books, articles and observations stretch back from the present day to near pre-history. Even Jesus is quoted as giving an insightful observation when he advised someone to "give unto Caesar what is Caesar's and unto God what is God's" , noting that money is really the property of the state; that we are only using it. I cannot claim originality for much of the material given here; I am only offering my point of view and the results of my thinking and analysis, hoping to help bring about that time when we all have a better understanding of money and can use that understanding for the betterment of our world community rather than having it used as a tool for the creation of individual and group power.
We can start our quest to understand money by considering why there is such a thing as money. Why was it needed? How did it come into being? A real hermit would not need money. Living alone and out of contact with other people he would never need nor have an opportunity to use money. Likewise, a very individualistic and conservative person who can build his own shelter, provide for his own food and make his own clothes would not have a real need for money. He would only need money if he wanted things or services provided by others.

From these observations we can see that money is coupled with living with other people, living in a community and depending on others to provide some parts of our needs while we, in turn, supply some of the needs of others. Money, then, is the enabler of a collective society where people depend on each other to supply their needs and diverse desires. It is important to note the collective society enabled by money is not necessarily akin to the one described by Biddle who is more interested in current liberal vs. conservative notions. Here, in my references, a "collective society" is merely one where people depend on the labor of others to satisfy their needs and desires. Both societies described by Biddle meet this definition. In fact from all that we know about man and his evolution through pre-history, we have always been a collective society. Even cave man had his artists who ate, lived and thrived while someone in his collective group provided him food and shelter. Hence, it is fair to say, we as humans cannot conceive of a society that is not a collective society, where people depend on the labors of others to provide some of their needs and desires while, in turn, they also provide to others using their own capabilities.

One change through history has been the evolution of the size of the collective group. Grouping probably started with family groups then grew to tribes and evolved under strong leaders to groups of tribes finally becoming states and nations as we have today. The fuel for this ever expanding size of groups has been transportation and communication. And it is not an overstatement to suggest we have reached very near the pinnacle in both areas with fast, world spanning transport and earth spanning communications. Both transportation and communications will, without doubt, improve with technical advances and development over the coming years but we now have the basis for a worldwide, collective society. Our current struggles with international trade and the interplay of monetary systems attest to the efforts to make the worldwide collective society work. But the people involved in this daunting work to enable international trade and solve monetary conflicts would not define their goal as creating a global collective society. They might even be peeved to be accused of such an activity but that, very definitely, is what they are doing. Sometimes you need to look down and back in order to see forward and up.

Another change/evolution has been the increased diversity of things we depend on others to supply to us and for which we use money to secure. A century and a half ago the important things requiring money were very limited compared to the highly diverse things and services now available in the market place. This increased diversity of commodities and services acquired with money obscures the basic function and original need for money. We can fail to see money as a tool to enable us to live with others and depend on them for our needs and, in turn, their dependence on our own productive work to supply something of value to others in our lives.

If we accept the notion that money is the enabler of a collective society where people depend on each other for their livelihood requirements then we do make money a commodity with ethereal qualities. How many movements, rally's, speeches, inspirational courses and organizations have the objective to achieve a society where people depend on each other and care for each other? Could we say every religion we understand and perhaps those we do not fully comprehend have as a goal "the brotherhood of man" and respect and service for others? Could it be that this stuff we call money is the key to attaining these lofty goals proclaimed by noble persons throughout history? An admonition about money well known to us is given in First Timothy 6:10, "For the love of money is the root of all kinds of evil." And it can be but it does not have to be.

The academic study of money is relegated to a portion of the subject of economics and economics describes itself as an "inexact" science. This assertion may be the only completely acceptable statement to ever be made by an economist. The field of economics is often overfilled with attempts to justify existing practices in business and in banking and is all too willing to bypass logic in order to make these justifications in their "inexact" way. One such justification is about the creation of money. Economists state and all too many people believe that banks "create" money. However simple logic, a gedanken experiment, disproves this assertion. In our monetary system, banks do not create money. Making entries into a journal do not make money. The existence of the FDIC is a testament to the fact banks do not create money. The law making it a federal crime to advocate making runs on banks is another statement that banks do not create money. Bottom line, banks use money but they do not create money in our system.

The question "What is money?" becomes much easier to answer when we apply logic to the issue and discount the fables such as the creation of money by banks. If we discount the other head scratching assertions that "credit" and "debt" are money then we can understand what money in our system really is. It is a commodity, a very inexpensive commodity, produced by the Bureau of Engraving and Printing (BEP) in the US Treasure Department of our government and the coins produced by the US Mints. It is inexpensive because the BEP produces a $100.00 bill for just 9.7 cents. Coins are more expensive to produce and lower denomination bills have a higher cost to value ratio. The 100s were less expensive to produce until a more sophisticated process was applied in recent years to foil counterfeiters. A new $100 is promised in the later months of 2013 and it will probably be more sophisticated and costly to produce.
Money is then a bartering commodity with a widely accepted value. It simplifies the bartering process with the buyer having a commodity of accepted value to exchange for the sellers commodity or service at the price offered by the seller. Money simplifiers the bartering process by requiring only the buyer to evaluate the value of the offered item rather than both parties having to evaluate the value of the item offered by the other.
Many will disagree with the assertion that banks do not create money. But simple logic easily shows they do not. Go through the process of getting a $1000.00 loan at a bank where you have an account. The bank official does the two entries, one in your account showing you have an additional $1000.00. Write a check to yourself and go cash it at a teller. The teller will hand you $1000.00. Then ask the question, "Did this cash just appear when I got the loan or was it here before?" The answer is obvious, the cash was there before the loan was made in the tellers drawer or stored away as vault cash. The loan process did not create the money. The loan process only gave you access to cash the bank was already holding. And the bank does not have the money really to loan to you. They will probably have 80.00 in reserve to "back up" the 1000.00 they loaned you, assuming a nominal 8% reserve requirement. So what is the bank doing using this fractional reserve process? They are engaging in this most ancient fraud developed by banks ages ago and still being used to this day. Why is it fraud? Look at the definition of fraud. That is precisely what banks do in the loan process. Those who claim banks create money by the fractional reserve loan process are being shrills for banks, trying to legitimize an obviously fraudulent process. Banks don't create money, they draw interest on money they do not have.

The above is a micro view of money as it is used by banks. Turning now to a macro view we encounter the most important obligation of managers of a monetary system; to provide the proper amount of money into an economic entity. The proper amount is usually defined in terms of its effect on the economy, not by a precise amount. The proper amount will provide a low unemployment rate which has been defined as "full employment" and will sustain an economy with stable prices; that is, neither inflation nor deflation is occurring. You may want to pause and read that again. It is fact. The independent monetary authorities have the power of employment/unemployment and inflation/deflation by controlling the money supply. Now, let's look at some money supply data. The
curve at left tells us a lot. A mathematician's eye will see an exponential curve. He would like to see an expanded scale plot for the 1913 to 1939 data to understand that period better. We can also see the very obvious bump up in 1940 at the onset of WWII. Those of us old enough to remember know what happened as the going to war economy boomed and everyone Figure 1 Historical Data: Money In Circulation
was working to support the war effort. People said the war caused the economy to pick up but the real reason was a buildup of money in the economy spurring the economy. There is a very prominent peak near 2000 that is well explained in the literature by the boom and bust of the "dot com" bubble. Another feature in the curve is the short flat segment near 2008 near 800 billion followed by a very sharp rise in 2009. Before discussing that subject we need to look at some features of our monetary system.
We have had many monetary systems in our country. One of the oldest and the longest enduring one was the use of bales of tobacco for money. Tobacco was an important export product and had an acknowledged value. Tobacco was used as money for over 140 years during the colonial period and it proved Gresham's law again. Plantation owners sold or smoked and chewed their best tobacco and used the least valuable as money. The Articles of Confederation (1781) did not contain any specific definition of a monetary system for the new nation but did give Congress the power to define coins by alloy and value. It has been rumored that the nature of the nation's monetary system was a hotly debated issue during the creation of the Constitution that replaced the Articles of Confederation ten years later in 1791. Again, the rumors are the delegates creating the Constitution agreed to disagree on a specific monetary system and again left the burden on the shoulders of the Congress, giving them again the power to coin money and set the value thereof.

Congress acted quickly, chartering the First US Bank in 1791 for a period of 20 years. Alexandria Hamilton, who was Secretary of the Treasure for President Washington, was the primary backer of the new bank, using the Bank of England as a model. Prominent persons, Thomas Jefferson and James Madison, were opposed but Washington finally signed the "bank law". The charter was not renewed in 1811 and over a period of 6 years there was no US central bank. The second US Bank was chartered in 1817 again hotly debated between industrial interests who favored the bank and agrarian representatives who opposed it. It was also charted for 20 years and again, in the famous "bank war" of Andrew Jackson, the charter of the second bank was not renewed. From that date in 1836 the US would not have a central bank again for 77 years when the Federal Reserve System was born in Dec of 1913. Over the 100 years of the Fed's life time many very significant things have happened resulting in great impacts on the central bank system. Some of these changes have been very visible and have been vigorously debated while others have been overlooked and just became "a part of the system." One very positive change the Fed brought to the nation's monetary system was to establish a uniform currency. In the preceding national banking era each bank designed their own notes, leading to confusions and difficulties described succinctly in an article by the Philadelphia Fed:








The Federal Reserve Act, which was an agreement between bankers and congressional representatives, included provisions for the government to print notes for all banks, to be distributed by the Fed, thereby establishing a uniform national currency. This responsibility resulted in the formation of the Bureau of Engraving and Printing (BEP) as a part of the Treasury Department. Establishing uniformity of bank notes was probably the first positive result of the formation of the Fed. These notes were just paper, showing how much "real money" a bank owed to the bearer of the note. They remained "just paper" for about 20 years, until FDR in 1933 removed the gold backing of the notes. Gold backing is still a vigorously debated subject today but little debate has occurred on the subject of the BEP now selling real money to the Fed for the cost of printing. The issue is seigniorage, the difference between the cost of producing money and the face value thereof. It is a very simple concept but, in order to explain away the government printing and selling money at cost to banks, a sophisticated "fairy tale" has been developed about the rebates the Fed gives to the US Treasure based on interest they collect on their holdings of the national debt. The "cover story" for seigniorage of Federal Reserve notes has been contrived. To fully understand the nature of real seigniorage we need to look at the options available for a national monetary system which are discussed and described below.
The US currently has two separate and distinct monetary systems in operation, coins and paper notes, and they work together in a seamless fashion. Coins are minted by US mints and placed in the governments account at face value regardless of the cost of minting the coins. The seigniorage for pennies and nickels is negative; it costs more to mint them than their face value. The other coins have positive seigniorage; a quarter costs just 11 cents to mint and dollar coins are minted for just 18 cents.
Paper notes, on the other hand, are printed by the US Treasure's Bureau of Engraving and Printing (BEP) and then sold to the Federal Reserve for the cost of printing. A $100 bill costs just 9.7 cents to print and it is printed with great sophistication to foil counterfeiters. It is informative to follow a $100 bill through a potential lifetime. The bill is printed by the BEP, sold to the Fed for 9.7 cents and then potentially used by a bank to buy a government bond. Assume it is a 10 year, 6% per year bond. The government then must tax citizens $6 per year for 10 years to pay interest on the $100 and then tax for the full $100 to repay the loan. In the cycle citizens are taxed $160.00 so the government could borrow and repay $100 that the government originally sold to the banks for 9.7 cents. Alternatively, the government could have printed the bill and spent it to pay a government expense, paying a $100 debt for a cost of 9.7 cents to citizens. That is 1,650 times less if the government had taken the full seigniorage instead of passing it on, thereby increasing the wealth of banks.
There are no political discussions of the question of the government printing and spending money into the economy to pay its bills versus borrowing money, paying interest and collecting taxes to pay its bills. The subject is anathema in our politics. It is anathema because it is such a threat to the power and wealth of the banks and financial sector generally as the numbers above show. Politicians are afraid to discuss the subject, afraid because of the power of banks to retaliate for any suggestion that a sovereign government should issue money into its economy rather than allowing privately owned, for profit banks the unique privilege of issuing the national currency into circulation. But it is a discussion that is needed and needed now for many reasons.
A discussion of the nations monetary system would be classed as "boring" and "confusing" to many. One reason for that is that no one alive today remembers any monetary system other than the 100 year old Fed. The Fed is accepted by many as the only way for a monetary system to work. Another stumbling block is the disconnect between the value of money to us as individuals versus the cost to produce the money. While slipping a crisp $100 bill into our wallet it is hard to grasp the fact, and the significance of the fact, that the $100 bill cost the government only 9.7 cents to make. But it is a fact and it is a very significant fact.
The BEP, a very efficient and highly developed operation, produces about 1.5B$ per day with a majority of the production being 1$ bills. They claim about 90% of the production is used to replace worn/torn/unusable bills culled out by the daily activities of the Fed. This means the Fed is shredding and burning over 1B$ in cash each day. What does all of this mean? First, it obviously means that money is a very inexpensive commodity and that the US Treasury's BEP is very good at making it. The second point is less obvious; that the inexpensive nature of money is very good news for the government, for our economy and for our way of life. The discussion needed about the monetary system is to first explore and understand these advantages of inexpensive money, second, to explore why our present monetary system, the Fed, blocks us from enjoying these benefits and third, to understand the structure of a monetary system that will enable us to fully enjoy the personal and community benefits of inexpensive fiat currency.
Many readers at this point will be saying "Wait a minute, the government can't just print money and spend it because that will make the money worthless." And that observation is true and it is true for any monetary system, not just a government run monetary system. It points up the single most important feature of any monetary system; how the total supply of money is controlled to provide an adequate supply to sustain employment and the economy but not too much to create inflation and debasement of the currency.
Supplying too little money to an economy is an oppression of the citizens, robbing them of the ability to help each other by the free exchange of money for goods and services. Putting too much money into the economy leads to the frustration of increasing prices plus the debasement of savings. Unfortunately, both of these conditions can benefit certain groups in a community. A well designed monetary system must guard against being used to inflict either of these conditions on an economy for the benefit of a select few.
There are historical examples of both too much and too little money in an economy. An example of too much money in circulation is Nazi Germany in the '30s. The hyperinflation was created to enable Germany to pay reparations demanded by the allies following Germany's defeat in WWI. It worked. Germany paid off the reparations but at the expense of the frustration and pain of the German people suffering through the hyperinflation. And the world learned. Following WWII the Marshall Plan was devised to assist the defeated nations in rebuilding their economies and rejoining the community of nations rather than imposition of reparations.
We in the USA have experienced the "too-little-money" in circulation syndrome. It happened during the great depression of the '30s and it has happened again in the 2008 downturn. The visible indicators of the situation are copious signs of property for sale, real estate, homes, cars and many other items. People are forced to sell their property to obtain cash money and they are forced to sell at ever lower prices. There is a whispered name for this situation among those benefited by it. It is a "liquidation phase" where people are forced to sell property because of the sacristy of money imposed by the monetary system.
Both property and labor are liquidated when too little money is in the economy. Workers must liquidate their labor by working for ever lower wages. The groups who benefit from this situation are obvious. Those with saved money can purchase property at lower prices and employers can hire workers at lower wages. A well designed monetary system must be designed and policed to prevent it from being used to create either of these conditions; hyperinflation and debasement of the money supply or from the oppression of the population by an inadequate supply of money.
The tools available to a monetary system to control the money supply are an important consideration. A comparison can be made between our current monetary system, the privately owned central bank model we call the Federal Reserve and a government controlled monetary system. The Fed is charged by law with maintaining the money supply to avoid inflation and enable full employment. The primary tool it has to accomplish this task is buying and selling of government debt making a government debt necessary for operation of the central bank. Buying government debt puts money into bank reserves enabling banks to make more loans there by increasing the supply of money. The procedure can be reversed to reduce the money supply. It is a back door method depending on bond sellers to make deposits in American banks and depending on banks to make more loans when their reserves are increased. It is also a slow acting method, requiring many months to be felt in the economy.
The need for a national debt to support open market operations (as the process of buying and selling of government debt by the Fed is called) is very real as was shown during the late 1990s. The budget surpluses and projected debt reductions in the later part of the 90s under President Clinton frightened the monetary community with the prospect of a mortal blow to the Fed by having the national debt totally retired. The problem was "fixed" under the following Bush administration by the Bush tax cuts and expenditures on the war on terror.
Maintaining a stable money supply to serve the nation and the economy is a responsibility of the central bank. The oft stated target by the Fed for a "stable" supply is a growth rate of 3% per year. Over the 100 year life of the Fed that would be a 19x increase in the money supply. The actual increase has been much larger. Per http://www.clevelandfed.org/research/workpaper/2013/wp1304.pdf currency in circulation in 1914 was 1.85B$ and in 2013 the number is 1.6T$, a real increase of 864 times or an average rate of 7% per year.

A quietly held secret of the Fed is that a steady, inflationary, compound interest-like growth in the money supply is a necessary result of the central bank monetary system model. Historical data confirms it as fact as noted above. The money supply versus years plot shown above can be modeled accurately by compounded interest at a nominal rate of 7% per year.
The reason for this is not difficult to understand. When banks loan a quantity of money into the economy for a period of time, say one year, then they must loan the same amount plus interest on the previous amount in order to maintain the money supply. If they don't loan this ever increasing amount the money supply shrinks, unemployment mounts and foreclosures on loans must occur because of the simple fact that not enough money is available in the economy to repay previous loans at interest.
This guaranteed inflationary character of the central bank model is often justified by the assertion that a government operated monetary system, where money is issued into the economy by government spending, is inflationary. The fact is the exact opposite. In a government operated monetary system, where money is issued by spending, it does not have to be returned as with loans and importantly, with no interest attached to them. This enables establishment of a non-inflationary, stable money supply.
Evidence of this fact can be seen in Figure 1, above. There is the ramp up of the money supply in the early '40s to accommodate the expenses of WWII followed by a very stable period reaching into the '60s. During this period the government introduced US Notes into the economy by direct spending to pay for the costs of the war. The issuing of US Notes stopped Jan 21, 1971. It is noteworthy too that the US economy was booming in the war years and the years after. It was not a coincidence that these economic boom years occurred during a period of government spending of US Notes and a period when 100s of thousands of young men and women were given free college educations under the "GI Bill".
A government operated monetary system, in addition to being free of the mandatory inflation of a central bank system, also has better and faster tools to manage and control the money supply. The money supply can be increased directly by spending or reduction in taxes compared to the indirect methods of the central bank; buying of government debt and adjustments to bank to bank interest rates. The government can reduce and slow the growth of the money supply by reduced spending, increased taxes and by borrowing money, all very direct methods. Both the directness and the speed of the money supply control tools available to the government recommends them for the task of management of the money supply rather than a private group such as the Federal Reserve with only slow, indirect tools.
Our present situation in the US is a great case in point. Consider the construction industry, its unemployment status and the countries well known, crumbling infrastructure of roads, bridges and buildings. A recent figure for unemployment in the construction industry was 8.5% in a work force of 5.8 million or about 500,000 people. Think about what those 500,000 workers could accomplish over a period of two years repairing our crumbling roads and bridges. It would be enormous. And how much would it cost tax payers? We have to remember that if those construction workers get busy then many others get busy too supplying materials to those workers and responding to their increased demand for goods they can afford now that they have a job. It would be an economic boom. Now, the cost. Let's make a guess, maybe high, maybe low but say $200,000 per year for two years for 500,000 workers. That's a total of 200B$ into an economy that currently has 1,200B$ in circulation. That is a big increase in the money supply, about 17% but what effect would it have? Let's assume it is issued by the US Treasury under the Legal Tender Act of 1862 as "lawful money", the term applied to currency issued directly by the US Treasury, also referred to as "US Notes". These US Notes would not cause inflation because they cannot, under law, be used as reserves by banks and multiplied by a factor of 8 to 12 times by fractional reserve loans. The US Notes are also called an "inelastic" currency for this reason. And getting back to how much it would cost tax payers, we can use the current printing cost of a $100 Federal Reserve note as a guide. A $100 bill costs less than 10 cents to print, a 1000:1 ratio called seigniorage. So the actual cost to tax payers would be, more or less, a paltry, insignificant 200M$. With about 200M$ we put a million unemployed Americans to work, giving them a new lease on life. We get a bustling economy, we get a renewed infrastructure, repaired bridges, roads and buildings which will be a very real increase in the wealth of the nation provided by the labor of a half million now unemployed citizens. And a last, very real benefit: that 200B$ spent into the economy is a unique currency. It accrues no interest and does not have to be "paid back" as fed notes do, providing a continuing, stable money supply that can be used by citizens to enjoy the labor of others in exchange for their own chosen labor.
So, why isn't it done? Would anyone be hurt? It looks like the citizens of the country and the nation at large would all win. Yes, but some would be hurt and suffer a very significant hurt. That 200B$ of lawful money placed into the economy and staying in the economy will "rob" banks of a nominal 14B$ per year(assuming a nominal 7% loan interest), every year as long as the US Notes remain in the economy because banks will not be required to loan the funds at interest that are already in the economy. This is obviously why, very quietly, the issuance of US Notes was curtailed as of Jan 21, 1971. The trajectory of our economy from that date may, at least in part, be due to that curtailment of the issuance of US Notes.
Of great importance here is that the purpose of this discussion is not to punish banks or "get back" at them or to take away their historical privileges. The reasons are pragmatic and are based on the competitive position of the country in the world, the health of the economy and the welfare and standard of living of the citizens of the country.
Thank you,
Charles Layne,
October 29, 2013