October 8, 2013 | Posted in Public Presentations | By

Money creation is a government function. Reversing the privatization of money creation will render the debt ceiling and government borrowing obsolete.

As I write, the US Congress is locked into a stalemate over the issue of raising the debt ceiling of the US Government. The issue of an ever increasing government debt forces us to lurch from one political crisis to the next. The current government shutdown and the looming default on US government debt are the handiwork of an irresponsible minority of ideologues in the House of Representatives using Congress’ power of the purse to subvert the democratic legislative process. They are undermining the very foundation of our democracy and endangering our economy. But, even in the absence of saboteurs in the very halls of Congress, the problem of an increasing level of government debt combined with a weak economy presents a very hard problem to solve, at least within the confines of conventional thinking.

First let’s look at the problem and then at the solution made available by some thinking outside the box.

Let accept for the time being the conventional wisdom that we need the economy to grow again (in a later blog post I will explore why economic growth is not the way to address the economic needs of the vast majority of the population). We measure growth in the economy by looking at the growth in GDP (Gross Domestic Product). If GDP contracts for two consecutive quarters we are officially in a recession. So let’s look at the components of GDP and figure out why growth in GDP has been anemic since the economy resumed growing in the middle of 2009.

GDP = C + B + G + (X-I)

C             stands for consumption, the amounts of goods and services purchased by individuals

B             stands for investments made by the business sector

G             stands for government investments and spending

(X – I)    stands for the difference between our exports to other countries minus what we import from the rest of the world

Our economy is heavily dependent on consumer spending, in fact C has historically accounted for roughly 65% of economic activity. Business investments are a function of the business cycle. In good times businesses are more optimistic about their ability to find buyers for additional products and services and invest to increase their capacity to produce. B has been fluctuating over the last couple of decades around 15% of GDP. Government investments and spending has hovered at around 20% of GDP.  The difference between exports and imports has not been a significant component of the GDP in the last few decades.

Consumer spending fueled most of US economic growth since the end of World War II and was made possible by raising real wages in every decade until the 1980s.

productivity-and-real-wages (BLS)

Since then real wages have been flat, in other words the purchasing power of Americans who worked for a living has stagnated. The growth in consumption and hence most of the growth in GDP since the early 1980s was made possible by two strategies the US middles class adopted to keep up the illusion of the American dream – an ever increasing standard of living. The first strategy required more members of the family joining the labor force – mostly stay-at-home moms gaining employment outside the home.

The second strategy was to borrow first to buy homes, then by using credit cards, by taking out larger and larger student loans and finally by borrowing against the value of the equity in ones’ homes. Those strategies are now exhausted. Real wages continue to decline and the few jobs that are being created of late for the most part pay less and are less stable than those lost during the recession of 2007-2009.  In other words, for the foreseeable future we cannot count on the middle class to drive economic growth through consumption. C is dead in the water. What about B? Businesses in the US are currently sitting on about $1,700 B in cash unwilling to invest it in the US for the very obvious reason that they do not see sufficient aggregate demand, in other words buyers, for the additional products and services those investments would create.

In other worlds, as long as C is dead in the water, B is dead in the water. What are we left with? Government spending is the only component of GDP that can support economic growth at this point and reverse the downward spiral of our economy. The economist John Maynard Keynes recognized this problem in the middle of the Depression of the 1930s and showed how government spending is necessary during recessions even if it results in higher levels of government debt. Yet government spending would at this point require either higher taxation or additional government borrowing. Higher taxation in the current US political reality would fall primarily onto the poor and middle class as opposed to the very rich or wealthy corporations that could well afford it since the latter finance our political process. Such regressive taxation will exacerbate the problem of stagnating consumption. Higher government borrowing is opposed by a political class that seems to be oblivious to basic economics and apparently incapable of simple observation – any attempt made by governments in recent history to reduce their debt during a recession has led to an even greater contraction of economic activity hence exacerbating the country debt to GDP ratio.

So, if Government spending is the only way out of our economic crisis and additional taxation or Government borrowing is out of the question how do we get out of this pickle? As Dwight Eisenhower suggested – if a problem cannot be solved, enlarge it.

To solve the problem we need to think outside the box and enlarge the scope of the problem to include the design of the money and banking system.

Most lay people if asked “who creates the money used by the nation?” may respond “the Government”. Some might think that the Central Bank (the Federal Reserve in US) creates money and that the Central Bank is part of the government. Very few pause to reflect on the fact that if the government creates the money we all use either directly or through its central bank then there would be no need for the government to borrow money.  It turns out that the subject of money creation has become a taboo in our society. The main reason for this taboo is the spectacular injustice of a fundamental government function – money creation, being almost completely privatized considering that such privatization represents the largest transfer of economic wealth and power in the history of human kind from the public at large to a private elite.

To gain a basic understanding of the current design of the money and banking system please check out this link. The key point to understand is that more than 95% of our money supply is electronic money created by the private banking sector when it lends it into existence. There are a couple of ways to look at this process. One way is to say that the private banking sector monetizes borrowers’ promises to repay – in other words, it turns borrowers IOUs into spendable bank IOUs. Another is to say that the private banking sector created upward of $9 Trillion dollars of electronic money (demand deposits and time deposits in the picture below) with which it purchased its income generating assets in the form of commercial and individual loans, real estate loans, treasury bonds, MBSs, CDOs and other investment assets.

aggregate balance sheet US commercial banks

All the money we use, physical currency and electronic money created by the private banking sector is backed by the full faith and credit of the US and is accepted in payment of taxes by the US Government. The Government is also periodically called to guarantee a portion of the electronic money created by the banks (those representing FDIC insured deposits each $250,000 or less) or to rescue the too-big-to-fail banks when their reckless lending threatens the entire national system of payments. So while the US Government, through its full faith and credit and taxing power, therefore all of us collectively, guarantees and bears the risk of the money creation process of the private banking sector, it has to borrow that same money from those that either have the privilege to create it – the private banks, or from those that have accumulated substantial wealth in their hand- rich individuals, wealthy corporations and central banks around the world.

The solution to our economic conundrum is therefore very simple. The Government needs to reclaim the quintessential government function of money creation. During the Civil War the US Government issued through the US Treasury debt-free money in the form of paper currency known as Greenbacks with which if financed the war with the South. It is time the US Treasury resumes the issuance of debt-free money as long as inflation is low and stable. The new money could be used to launch a massive government employment program similar to the WPA to rebuild the 70,000 structurally deficient bridges in this country, to rebuild the crumbling national infrastructure, to hire a new generation of young farmers that will transform the wasteful and destructive industrial agriculture into sustainable small scale organic agriculture, to invest in education and health care (as opposed to the sick care) of the US population, to support the basic human needs of the most vulnerable in our society. Another idea, which will soon be put up for a vote by the Swiss government, is to provide a national dividend to all adults in the country.

Once the economy is stabilized with the debt-free government spending outlined above, we can start using additional debt-free money creation to gradually retire some of the government debt. Regardless of the use of such debt-free money, reclaiming for the Government money creation, which is a fundamental government function and privilege, will be the best way to finally address the needs of regular people in this country while at the same time removing the weapon of the debt ceiling from an irresponsible minority in Congress bent on sabotaging our democracy and the rule of law.

Marco came to the US as a Fulbright scholar in mathematics and economics at the University of California in Berkeley. After a stint in the financial industry, Marco worked as visual artist on a full-time basis for 5 years and obtained a MFA focusing on the intersection between public art and ecology. He later worked for 6 years managing investment equity portfolios primarily on behalf of large foundations and endowments. In April 2009 Marco left the finance industry and has since been instrumental in the formation and development of the Slow Money Northern California chapter. He is sharing his experience doing direct Slow Money investments with communities around the country to help them increase their capacity for local investing. Marco is currently developing Essential Knowledge for Transition – a curriculum for engaged citizens to understand the money and banking system, the economic system and the financial system and how we need to transform them.

5 Comments

  1. Norm Conrad
    October 9, 2013

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    As your productivity vs. wages graph shows, the divergence began in the 70s, not the 80s.

    Frankly, I, as I’m sure you do, find the concept behind GDP to be corrupt. It implies that all spending is productive and equally productive. As one version of the joke goes,

    Who is the most productive person in America?
    The one who, upon leaving the hospital from receiving chemo therapy for cancer crashes his car on the way home while hearing on the phone that the house is on fire.

  2. Chad Broadus
    October 9, 2013

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    That’s been tried before. It didn’t go so well. http://www.rense.com/general76/jfkvs.htm

  3. Loni Gray
    November 12, 2013

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    Another thing the Government should spend those Greenbacks on is tightening and remodeling all our leaky single and multi-family dwellings. Add to that rethinking their current and potential uses and design in spaces for the kind of uses and activities we need to do in them today- like making, storing resources and materials, rental or income generation, companionship, and local cultural activities.

  4. Loni Gray
    November 12, 2013

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    http://www.rense.com/general76/jfkvs.htm
    So Chad, & Marco – if this is still on the books, and valid, how might we get it going again without assassination?

  5. Marco Vangelisti
    November 12, 2013

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    Well, the answer is building a movement around it. Congressman Dennis Kucinich (D-OH) introduced exactly the type of reform I outlined in this blog post – the NEED Act (H.R. 2990). They dispatched him not by assassination but by re-destricting him out of office. Any lone politician that is bravely challenging the status quo will not succeed in the absence of a popular movement supporting her effort. Look at the changes in society around marriage equality and recreational use of cannabis. Politicians can push for them now because there is wide understanding and support for those reforms. That’s why I created EK4T – to build the understanding and movement required for something like H.R. 2990 to become a reality without anyone getting killed 🙂

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