Somebody asked me today if the $1.5 trillion in “capital” injections by the Federal Reserve would be helpful to the economy.
The question terrified me because it really brought home the fact that most people in this country have no idea what’s going on economically.
Most people have no idea what these proposed policies actually mean or how useful or dangerous they might be. If you’re one of “most people,” I beg you to read this article; this stuff is so important, we should all have a basic understanding of it.
If you earn or spend money in the U.S., it would benefit you to understand how that money is created. We no longer create new money by mining, printing, or minting it; money is now created as an instrument of debt. Each dollar comes into existence only as it is loaned to someone and this process is explained by what is called the credit theory of money creation (CTMC).
The Credit Theory of Money Creation
Let’s say that I owe you $10. I write out a $10 IOU on a slip of paper and give it to you. You can then use that IOU as money; it can function as money because it represents a future payment of my debt to you. As you trade the IOU with other people for goods and services, it circulates in the economy until it eventually comes around to me again. When Karen owes me $10, she pays me with my original IOU and, in what’s known as the act of debt “redemption,” I cancel my initial debt because I now only owe it to myself. The Federal Reserve does the same thing on a national scale, redeeming the debts as they return to the government in the form of paid taxes.
Money created in this way is called “fiat” money because it’s created out of nothing more than a decision to print it: a law, a legal decision, a government policy. That’s in direct opposition to “hard” money that might be created (as one example) by pressing gold, an actual commodity, into a coin.
The CTMC states that money can be created by debt because, ultimately, money is debt. But the CTMC isn’t the only theory regarding how money can or should be created. Other theories compete with the idea that money is debt, arguing that money is more correctly defined as a medium of exchange, a store of value, or even a commodity like salt, cigarettes, or Tide laundry detergent, all of which have been used “as money.” We won’t solve this argument here; just know that the economists who agree that money = debt won the political debate and have been creating American money in accordance with this theory for over a century.
But that doesn’t mean there aren’t a lot of us out here still arguing against this system of “monetizing debt.” In fact, the credit theory of money creation is what most people find to be particularly irresponsible about government. It also illustrates a basic difference between capitalism and communism.
Capitalism is a system based on “capital” or saved resources. As such, capitalist debt is a very different animal than state credit. When someone wants a loan in a capitalist system, they are looking for saved money, not new money. If I want to start a business and need a loan to do so, I might approach a wealthy angel investor. The investor’s wealth allows him/her to save a big chunk of their money and invest it in my new business. This loan would be made with saved money or capital already in existence.
Communism is a system in which the government owns the means of economic production. As such, central banks are communist entities because they centralize, monopolize, and nationalize the means of money production. (If you question the idea of a central bank as a communist entity, you need look no further than Karl Marx’s Communist Manifesto in which he included central banking as his fifth measure of revolution.) So if I went to the Federal Reserve for a loan, any loan they’d offer me would be made with new money they created out of thin air in response to my request.
There are obviously some stark differences between these two economic theories, but the main difference is that, under the communist credit theory of money, nobody has to be fiscally responsible and save money to loan out, offsetting consumption in one area to facilitate production in another area. And that offset is key to sustainability: saving money, working with capital rather than credit as money, is the only sustainable way for a large-scale economy to function. On the small scale “debt money” can work (as socialism can also work on the small, family-sized scale) and there is evidence of “debt money” working throughout history (as evidenced by ancient tally sticks). But as the size of the economy increases, certain problems arise. If you’re at all upset about the rampant consumerism in our culture and the overconsumption that is now endemic in our society, you can blame the credit theory of money, which requires more and more consumption (spending) to keep that credit flow moving.
Plus, past a certain scale, debt redemption becomes almost impossible. While capitalism requires us to be responsible and “pay for” what we do by offsetting consumption and saving for it, communist credit theory places no such requirements. We can continue to print money out of thin air and obtain what we need for free as long as the debt eventually swings back around and is “redeemed.” It is an attractive and tempting idea. But on larger scales, the amount of debt becomes harder and harder to fully redeem.
For proof of this, just look at our current situation: the Federal Reserve’s balance sheet has expanded over the last 12 years to very unsustainable levels. After the 2008 crisis, that balance sheet expanded from $1 trillion to $4.5 trillion because of the bank bailouts. Between 2014 and 2019 the Fed then tried to reign things in and they redeemed the debt by about 750 billion as of last fall. But in the last five months, the balance sheet has re-expanded primarily because of a huge liquidity crisis in the banks that nobody is reporting on (that started in September of 2019) and we’re already back above $4 trillion now.
Here’s the problem: It took 5 years to redeem $750 billion in debt and only four months to re-monetize half of it ($375 million). It would take roughly 30 years to redeem the Fed’s current $4T in debt, but that’s assuming nothing goes wrong. We did have five good years from 2014 to 2019, but last year we experienced the liquidity crisis (which is still ongoing) and this year we have coronavirus. Is it really possible to have a 30-year span with no problems or crises demanding that we re-expand the money supply?
The idea is laughable.
The Fed will never be able to put this toothpaste back in the tube and redeem this debt. It will continue to grow until we reach a point of criticality and hyperinflation, which is a form of price inflation. That’s when the price of a loaf of bread goes into the thousands.
Faced with these two competing theories — capitalism and communism — the more sustainable and responsible course of action seems pretty obvious to people who actually look into the basic economics underlying the situation: we should be saving our resources (capital) and diverting that savings toward future wants, either offsetting our consumption or borrowing sound money (from others offsetting consumption) in order to fund our future wants and needs. Trying to get something for nothing with money printed out of thin air will still cost us, first with unsustainable resource consumption levels and later with hyperinflation.