Further Evidence that Economics is a Dismal Science

2017 February 28
by Daniel Lakeland

Look, there's a crapload of shitty information on the web about what the Federal Reserve Bank does, including a crapload FROM the Fed. Do they "print money" or not for example?

The problem seems to be that people are generally stuck on a very literal view of what it means to "print". So, this punning between two concepts, kind of like "statistical significance" and "practical significance" causes a HUGE amount of confusion.

Wikipedia explains this well: (as of this moment)

"Since central bank money currently exists mainly in the form of electronic records (electronic money) rather than in the form of paper or coins (physical money), open market operations can be conducted by simply increasing or decreasing (crediting or debiting) the amount of electronic money that a bank has in its reserve account at the central bank. This does not require the creation of new physical currency, unless a direct payment bank demands to exchange a part of its electronic money against banknotes or coins."

So, the Federal Reserve in its open market operations buys bonds from say Bank Of America. How does it do this? It simply increments a counter in the electronic records that describes how much reserve BofA has at the Fed. This then alters the regulatory status of BofA because it now has more reserves to meet regulatory reserve requirements. Therefore, it can lend more money without getting in legal trouble. Where did the money that went into the BofA reserve account come from? Nowhere. The FED takes in a promise to be paid money in the future (a bond) and gives out money it creates now (a reserve balance increment). The FED creates money. Traditionally, creating money is called "printing" but if you use "printing" as a technical term of the paper industry... you can claim "the FED doesn't print".

If you add up all the balances in BofA, plus the balance it has with the Fed, the total has increased. There is more money available to the world. Unlike Energy, money is not conserved, money is created out of thin-air (computing) by just increasing the balance on the accounting sheets at the Fed. Only the Fed is allowed to do this, everyone else has to *exchange* money (that is, to buy a sandwich you use a debit card to take money out of your checking account and put it into the checking account of the sandwich maker... the total quantity of money is unaffected because your balance decreased by the same amount that the sandwich maker's increased). If you use a credit card, the situation is the same, except with a greater time-delay and potentially if you're not paying off the credit card at the end of the month, with interest payments through time to the credit card issuer and soforth.

Is the Fed "printing money" in the sense of actually telling the Treasury to roll special paper through printing presses and putting special ink on the paper, and then shipping physical bills to banks? No. But, a balance in the Reserve Account at the Fed is as good as a promise to print physical bills whenever the bank wants them. That is, more or less, what the FDIC is, a big fat promise to run the presses when a bank can't hand out all the currency it's supposed to be able to.

In extreme situations, money might be destroyed. With the FDIC for example if you have more than some amount of money in your checking account, and there is a run on your bank, and the bank goes bankrupt, the FDIC will if necessary physically print you an amount of money equal to whatever your deposit amount was at the bankrupt bank... but only up to some limit, like $100k. So people who had $1M in their checking account might lose money in a puff of smoke... But this is an irrelevancy in most cases. It's also true that you can have $5000 in bills in your desk drawer when your house burns down... Again, not relevant to the overall picture in the world... which is that the Fed is able to create money when "money" is defined as all the balances in all the checking accounts and similar accounts, plus all the currency in vaults, plus all the reserve balances at the Fed. (The M1 money supply).

Practically speaking, whenever someone says that "the FED doesn't print money" (which as you see linked above, is something that even the FED says!) they are weasel-word lying. The FED doesn't print money in the same way that Artists don't make pen-and-ink drawings..... they just make the *ideas* that lead to the pen and ink drawings, it's an ink company that makes the ink, and a paper company that makes the paper... A stupid and meaningless distinction.

One Response leave one →
  1. March 1, 2017

    Something that I have never understood is why, when a central bank creates money, it never just gives it away, it lends it out at interest. Does it receive interest payments in perpetuity? Does it at some point receive back the original loan? Either case requires the banks to pay back more money than they received. Where does the extra come from? New loans from the central bank? How does this not turn into in a system of exponentially growing but fictitious debts from all banks to the central bank that no-one intends ever be paid back. In effect, giving the money to the banks but pretending it's a loan.

    Another aspect that I've never seen mentioned is that the use of debt as money does not in principle require any financial institutions. Suppose I lend you $10,000 and you write a promise to pay it back (perhaps plus interest) in a year's time. If that written promise is payable to its bearer, then I can use it as money with whoever is willing to trust your signature on it, at the same time as you are using my $10,000. Presto, $20,000 where there was $10,000 before, without any bank being involved. When the debt falls due, the extra $10,000 goes away (whether you can pay it back then or not).

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