“This isn’t about big
government or small government. It’s about building a smarter government that
focuses on what works.”
– Barack Obama, November 26,
2008
As our 44th President prepares to enter the Oval Office, bank lending has seized
up, some of the nation’s largest banks are on life support, and the big three
automakers are bankrupt. Housing continues to crash, and so does the economy.
Little wonder that Obama is being compared to Franklin D.
Roosevelt, who entered the White House in similar financial straits in 1932.
Even before taking office, Obama has started his version of the “fireside chats”
(updated from radio to online video) given by Roosevelt nearly weekly to
reassure the public. He said on November 22 that he plans to create 2.5 million
new jobs by 2011 and kick-start the economy by building roads and bridges,
modernizing schools, and creating technology and infrastructure for renewable
energy. These are excellent ideas, but what will they be funded with—more
government debt?
Obama has pledged to honor the commitments of the outgoing
administration to rescue financial markets, on the theory that if we don’t, our
credit system could freeze up completely. But as noted by Barry Ritholtz in a
December 2 article, the bailout has already
cost more than the New Deal, the Marshall Plan, the Louisiana Purchase, the
moonshot, the savings and loan bailout, the Korean War, the Iraq war, the
Vietnam war, and NASA’s lifetime budget combined. 1 Increasing the debt burden
could break the back of the taxpayers and plunge the nation itself into
bankruptcy.
How can the new President resolve these enormous funding
challenges? Thomas Jefferson realized two centuries ago that there is a way to
finance government without taxes or
debt. Unfortunately, he came to that realization only after he had left the
White House, and he was unable to put it into action. With any luck, Obama will
discover this funding solution early in his upcoming term, before the country is
declared bankrupt and abandoned by its creditors.
Jefferson realized too late that the Founding Fathers
had been misled. He wrote to Treasury Secretary Gallatin in 1815:
It had long been held to be the sovereign right of governments
to create the national money supply, something the colonies had done
successfully for a hundred years before the Revolution. So why did the new
government hand over the money-creating power to private bankers merely
“pretending to have money”? Why are we still, 200 years later, groveling before
private banks that are admittedly bankrupt themselves? The answer may simply be
that, then as now, legislators along with most other people have not understood
how money creation works. Only about 3% of the U.S. money supply now consists of
“hard” currency—coins (issued by the government) and dollar bills (issued by the
private Federal Reserve and lent to the
government). All of the rest exists
merely on computer screens or in paper accounts, and this money is all created by banks when they make loans.
Contrary to popular belief, banks do not lend their own money or their
depositors’ money. They merely “monetize” the borrower’s promise to repay. Many
creditable authorities have attested to this fact. Here are a few:
“[W]hen a bank makes a loan, it simply adds to the
borrower’s deposit account in the bank by the amount of the loan. The money is
not taken from anyone else’s deposit; it was not previously paid in to the bank
by anyone. It’s new money, created by the bank for the use of the
borrower.”
– Robert B.
Anderson, Secretary of the Treasury under
President Eisenhower
“Banks create money. That is what
they are for… The manufacturing process to make money consists of making an
entry in a book. That is all… Each and every time a Bank makes a loan… new Bank
credit is created—brand new money.”
– Graham
Towers, Governor of the Bank of Canada from
1935 to 1955
“Of course, [banks] do not really
pay out loans from the money they receive as deposits. If they did this, no
additional money would be created. What they do when they make loans is to
accept promissory notes in exchange for credits to the borrowers’ transaction
accounts. Loans (assets) and deposits (liabilities) both rise [by the same
amount].”
– The Chicago Federal Reserve, Modern Money Mechanics (last updated 1992)
Not only are banks merely pretending to have the money they
lend to us, but today they are shamelessly demanding that we bail them out of
their own imprudent gambling debts so they can continue to lend us money they
don’t have. According to the Comptroller of the Currency, the books of U.S.
banks now carry over $180 trillion in a
form of speculative wager known as derivatives. Particularly at issue today are
betting arrangements called credit default swaps (CDS), which have been sold by
banks as insurance against loan defaults. The problem is that CDS are just
private bets, and there is no insurance commissioner insuring that the
“protection sellers” have the money to pay the “protection buyers” if they lose.
As loans have gone into default, the elaborate gambling scheme built on them has
teetered near collapse, threatening to take the banking system down with it. Now
the players are demanding that the government underwrite their bets with
taxpayer funds, on the theory that if the banking system collapses the public
will have no credit and no money. That is the theory, but it misconstrues the
nature of money and credit. If a private bank can create money simply by writing
credit into a deposit account, so can the federal government. The Constitution
says “Congress shall have the power to coin money,” and that is all it says about who has the power to create
money. It does not say Congress can delegate to private banks the right to
create 97% of the national money supply in the form of loans. Nothing backs our
money except “the full faith and credit
of the United States.” The government could and should have its own system of
public banks with the authority to issue the credit of the nation directly.
Buyouts, not
Bailouts
Accumulating a network of publicly-owned banks would be a
simple matter today. As banks became insolvent, instead of trying to bail them
out, the government could just put them into bankruptcy and take them over.
Insolvent banks are dealt with by the FDIC, which is authorized to proceed in
one of three ways. It can order a payout, in which the bank is liquidated and
ceases to exist. It can arrange for a purchase
and assumption, in which another bank buys the failed bank and assumes
its liabilities. Or it can take the bridge
bank option, in which the FDIC replaces the board of directors and
provides the capital to get it running again in exchange for an equity stake in
the bank. An “equity stake” means an ownership interest: the bank’s stock becomes the property of the
government. 2 Nationalization is an option routinely pursued in
Europe for bankrupt banks. As William Engdahl observed in a September 30
article, citing economist Nouriel Roubini for authority:
“[I]n almost every case of recent
banking crises in which emergency action was needed to save the financial
system, the most economical (to taxpayers) method was to have the Government, as
in Sweden or Finland in the early 1990’s, nationalize the troubled banks [and]
take over their management and assets … In the Swedish case, the Government held
the assets, mostly real estate, for several years until the economy again
improved at which point they could sell them onto the market … In the Swedish
case the end cost to taxpayers was estimated to have been almost nil. The state
never did as Paulson proposed, to buy the toxic waste of the banks, leaving them
to get off free from their follies of securitization and speculation
abuses.”3
As in any corporate acquisition, business in the banks
nationalized by the government could carry on as before. Not much would need to
change beyond the names on the stock certificates. The banks would just be under
new management. They could advance loans as accounting entries, just as they do
now. The difference would be that interest on advances of credit, rather than
going into private vaults for private profit, would go into the coffers of the
government. The “full faith and credit of the
United States” would become an asset of the United States. Instead of
paying half a trillion dollars annually
in interest, the U.S. could be receiving
interest on its credit, replacing or
eliminating the need to tax its citizens.
3 Ways to Fund the “New” New
Deal
There are three ways government could fund itself without either
going into debt to private lenders or taxing the people: (1) the federal
government could set up its own federally-owned lending facility; (2) the states
could set up state-owned lending facilities; or (3) the federal government could
issue currency directly, to be spent into the economy on public projects. Viable
precedent exists for each of these alternatives:
1. The Federal Bank
Option
The federal government could issue credit through its own
lending facility, leveraging “reserves” into many times their face value in
loans just as banks do now. Franklin Roosevelt funded his New Deal through the
Reconstruction Finance Corporation (RFC), a government-owned lending
institution. However, the RFC borrowed the money before lending it. 4 A
debt-free alternative would be for a government-owned bank to issue the money
simply as “credit,” without having to borrow it first. This was done by the
state-owned central banks of Australia and New Zealand in the 1930s, allowing
them to avoid the worldwide depression of that era. 5 In the informative
booklet “Modern Money Mechanics,” the Chicago Federal Reserve confirms that
under the fractional reserve system in use today, one dollar in reserves is
routinely fanned by private banks into ten dollars in new loans. 6
Following that accepted protocol, the government could fan the $700 billion
already earmarked to unfreeze credit markets into $7 trillion in low-interest
loans.
Apparently, that is how Treasury Secretary Henry Paulson and
Federal Reserve Chairman Ben Bernanke are planning to generate the $7 trillion
they say they are now prepared to advance to rescue the financial system: they
will just leverage the $700 billion bailout money through the banking system
into $7 trillion in new loans. 7 But the Federal Reserve is a
privately-owned banking corporation, and the recipients of its largesse have not
been revealed. 8 The $700 billion in seed money belongs to the
taxpayers. The taxpayers should be getting the benefit of it, not a propped-up
private banking system that uses taxpayer money for the “reserves” to create ten
times that sum in “credit” that is then lent back to the taxpayers at interest.
Seven trillion dollars in government-issued credit could
furnish all the money needed to fund Obama’s New Deal with a few trillion to
spare. Among other worthy recipients of this low-interest credit would be state
and local governments. Many state and municipal governments are going bankrupt
through no fault of their own, just because interest rates shot up when the
monoline insurers lost their triple-A ratings gambling in the derivatives
market. 9
2. The State Bank
Option
While states are waiting for the federal government to step in,
they could charter their own state-owned banks that issue low-interest credit on
the fractional reserve model. Article I, Section 10, of the Constitution says
that states shall not “emit bills of credit,” which has been interpreted to mean
they cannot issue their own paper currency. But there is no rule against a state
owning or chartering a bank that issues ten times its deposit base in loans,
using standard fractional reserve principles.
Precedent for this approach is found in the Bank of North Dakota (BND), the
nation’s only state-owned bank. BND was formed in 1919 to encourage and promote
agriculture, commerce and industry in North Dakota. Its primary deposit base is
the State of North Dakota, and state law requires that all state funds and funds
of state institutions be deposited with the bank. The bank’s earnings belong to
the state, and their use is at the discretion of the state legislature. As an
agent of the state, BND can make subsidized loans to spur economic and
agricultural development, and it is more lenient than other banks in pressing
foreclosures. Under a program called Ag PACE (Agriculture Partnership in
Assisting Community Expansion), the interest on loans made by BND and local
lenders may be reduced to as low as 1 percent. 10 North Dakota
remains fiscally sound at a time when other state governments swim in red ink,
and its educational system is particularly strong. While disruptions in capital
markets have hampered student loan operations elsewhere, BND continues to
operate a robust student loan business and is one of the nation’s leading banks
in the number of student loans issued. 11 North Dakota’s fiscal
track record is particularly impressive considering that its economy consists
largely of isolated farms in an inhospitable climate. Ready low-interest credit
from its own state-owned bank may help explain this unusual success.
3. Government-issued
Currency
A third option for creating a self-sustaining government
would be for Congress to simply create the money it needs on a printing press or
with accounting entries, then spend this money directly into the economy. The
usual objection to that alternative is that it would be highly inflationary, but
if the money were spent on productive endeavors that increased the supply of
goods and services—public transportation, low-cost housing, alternative energy
development and the like—supply and demand would rise together and price
inflation would not result. The American colonial governments issued their own
money all through the eighteenth century. According to Benjamin Franklin, it was
this original funding scheme that was responsible for the remarkable abundance
in the colonies at a time when England was suffering the depression conditions
of the Industrial Revolution. After the American Revolution, private bankers got
control of the money supply, but Abraham Lincoln followed the colonial model and
authorized government-issued Greenbacks during the Civil War. Not only did this
allow the North to win the war without plunging it into debt to the bankers, but
it funded a period of unprecedented expansion and productivity for the country.
Obama would do well to consider these funding solutions for
his “smarter” government. He has been quick to assemble his advisers and form
policy, but a fast start down the wrong road could do more harm than good. The
bailout scheme of the current administration is serving merely to keep a failed
banking system alive by draining assets away from the productive economy. The
conventional wisdom is that we must continue down the path we are on, because
the alternative means frightening, radical change. Financing a new New Deal
without putting the country further into insolvency, however, would not be a
radical departure from tradition but would represent a return to our roots, to
the uniquely American monetary policy advocated by our venerable forebears
Benjamin Franklin, Thomas Jefferson and Abraham Lincoln.
References
1.
Barry Ritholtz, “Bailout
Costs More than Marshall Plan, Louisiana Purchase, Moonshot, S & L Bailout,
Korean War, New Deal, Iraq War, Vietnam War,”, Global Research (December 2,
2008).
2.
G. Edward Griffin, The Creature
from Jekyll Island (Westlake Village, California: American Media,
1998), pages 63, 65.
3.
“William Engdahl, “Financial
Tsunami: The End of the World as We Knew It,” Global Research (September 30,
2008).
4.
See Ellen Brown, “The Collapse of a
300 Year Ponzi Scheme,” webofdebt.com/articles, October 16, 2008.
5.
See “Sustainable
Energy Development: How Costs Can Be Cut in Half,” ibid., (November 5, 2007).
6.
Chicago Federal Reserve, “Modern Money
Mechanics” (1963, updated 1992), originally produced and distributed free by
the Public Information Center of the Federal Reserve Bank of Chicago, Chicago,
Illinois, now available on the Internet.
7.
Mark Pittman, Bob Ivry, “U.S. Pledges $7.7 Trillion
to Ease Frozen Credit,” Bloomberg.com (November 25, 2008).
8.
Ellen Brown, “The Fed Now
Owns the World’s Largest Insurance Company – But Who Owns the Fed?”, www.webofdebt.com (October 7, 2008); Mark
Pittman, et al., “Fed
Denies Transparency Aim in Refusal to Disclose,” Bloomberg.com (November 10,
2008).
9.
Tami Luhby, “Credit
Crisis Hits Main Street,” CNNMoney.com (February 21, 2008); “Bond
Failures May Bankrupt Cities,” Marketplace (February 28, 2008).
10. “The
Bank of North Dakota,” New Rules Project, newrules.org; “Ag PACE,” banknd.com (2007).
11. Richard Sisson, et al., The American
Midwest: An Interpretive Encyclopedia (2007), page 41; Liz Wheeler,
“Bank
of North Dakota Keeps Student Loan Funds Flowing,” Northwestern Financial Review,
BNET.com (September 15, 2008).
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