Daily Archives: October 19, 2013

How to Talk About Debt and Deficits: Don’t Think of an Elephant*

I think it is time to start talking about what is in this New Economic Perspectives article, How to Talk About Debt and Deficits: Don’t Think of an Elephant*

Here is a quote from a report prepared for publication by the St. Louis Federal Reserve that makes the point that we all need to understand:

The article even has a link to a YouTube video of Alan Greenspan making a similar point.

There is nothing to prevent the federal government from creating as much money as it wants to make.

To grasp the import of Alan Greenspan’s confession, it may help to read my previous post, Fractional Reserve Banking Mechanics. In my ordinary bank example, I said that the bank gave the borrower some physical bills. This was just so that you could keep track of the physical bills and see that they actually existed somewhere to cover what each person thought they had. The bank could just as easily have credited the borrower some money in his or her checking account. If the borrower then gave a check for the money to someone in order to buy something, the seller could have deposited the check in the business’s bank account. The banking system would be happy to tell the business that it had added the money to its account, all by transferring the idea of who had the money electronically. No physical bills need ever change hands.

If you grasp how a plain old bank manages to create money essentially from nothing, then you can see how much easier it is for the Federal Government to create its own money. With the advent of electronic transfer of “money”, the Federal Government does not even have to physically print money. All it has to do is electronically credit someone with the money. As long as almost everybody believes the money is there, and that the money people think they have will actually buy what they expect it to (and experience confirms their assumptions), then the system runs quite well.

As in the example in the previous post of how the Federal Reserve Bank created trillions of dollars to keep the banks afloat during the crash of the mid 2000s, you should be able to see how it would be possible for the Federal Reserve Bank to create enough money to pay the debts of the Federal Government.

If you have not thought of this before, you may be able to think of lots of circumstances where the creation of such money could become a problem. However, only some of the scenarios you come up with will be actual problems. Other problems just resolve themselves if you think about the reality hard enough, or you have someone explain to you how it resolves.

To make rational decisions, you really have to figure out which ones are the real problems, and which ones are just ghosts of your lack of familiarity with how money actually works on a large scale.

When even President Obama goes along with the fiction that we have a current debt problem, it is time to start getting seriously educated on what is and what isn’t a problem. Hint: The current debt is not the problem. The future debt from uncontrolled health care costs is the problem whether it is debt from the Government or debt from private individuals. (Read the report that is linked to Greenspan’s remarks above).

It is a real danger when the President gives up trying to educate the public, and thinks he can just harness public ignorance for his own benefit. It is guaranteed to blow up in his face, just as it has many times in his Presidency already.

How to Talk About Debt and Deficits: Don’t Think of an Elephant*, is really just the beginning of an understanding of this whole topic.

Fractional Reserve Banking Mechanics

To understand some future blog posts, you are going to have to understand some of the mechanics of the fractional reserve banking system.

I think I have come up with a simple enough example that allows you to see where the money goes among people, banks, cash, and debt.  In this simple example, we can even track the individual dollar bills.  I have chosen the numbers to make the math very simple.  It all still holds when you scale it up to large amounts of money and down to a more realistic reserve requirement.

Start with $16 in one dollar bills from the U.S. mint with serial number $#1 through $#16. We need 4 banks numbered B1 through B4. 5 People number P1 through P5.

For simplicity, let’s say the reserve rate is 50%. Let’s also say that dollar bills are not divisible.

P1 has 16 dollar bills that he deposits in bank B1. B1 keeps the dollars $#1 through $#8 as a reserve. It then lends $#9 through $#16 to person P2.

Person P2 has a debt of $8 and cash of $8 which he deposits in bank B2. Bank B2 keeps dollars $#9 through $#12 as reserve, and lends $#13 through $#16 to person P3.

Person P3 has a debt of $4 and cash of $4 which he deposits in bank B3. Bank B3 keeps dollars $#13 and $#14 as reserve, and lends $#15 and $#16 to person P4.

Person P4 has a debt of $2 and cash of $2 which he deposits in bank B4. Bank B4 keeps $#15 as reserve and lends $#16 to person P5.

Person P5 just keeps the dollar because banks do not accept accounts of $1 because they cannot lend out part of the indivisible dollar.

This can all be presented visually by a number of charts from a spread sheet.

In this example, at the end of 9 days as you follow the circulation of money through the system, you see that there appears to be $31 of cash in the system even though there are only $16 of U.S. Money created by the U.S. mint.

In other words the Fractional Reserve Banking system has just about doubled the amount of cash given a reserve rate of 50%. The multiplier on the amount of cash created goes up as the fraction of reserves required to be held goes down. If the reserve requirement were 10%, the multiplier would be close to 10.

Don’t be blinded to reality because this example has most people leaving their cash in the bank. If people took some money out of the bank to buy something, the money would end up being deposited somewhere, the effect would be the same, just the math and keeping track would be more complicated.

The power of this scheme becomes really obvious when you consider that a bank is taking deposits from large numbers of people. The bank holds only a fraction of that money in reserve. Under ordinary circumstances, not all depositors will want to turn all their deposits into cash all at the same time. If the normal number of depositors want take cash out of the bank, the reserves accumulated from all the depositors is enough to cover the request. No depositor has to be concerned that the bank is only holding a fractional reserve.

When some extraordinary circumstance arises where a bank’s customers want more cash than the bank is holding in reserve, the Federal Reserve Bank can supply the cash necessary to keep alive the fiction that the bank had the depositor’s money all the time. Even in some extraordinary circumstances, the money the depositors took from one bank will find itself deposited in another bank and the system can remain stable.

In the extraordinary extraordinary circumstance, where the request for withdrawal is more systemic than just a single bank, the Fed can just create enough U.S. Money and feed it to the banks to stabilize the system, as it did in the financial crash of the mid 2000s.

Any questions or comments? Post them on my Facebook mirror of this blog article.

America Wants No Cuts to Social Security

America Wants No Cuts to Social Security has posted a video and a petition.

According to the Conservative Intel Poll:

59% of respondents reported they were less likely to vote for a candidate who supports the chained CPI. Republicans (57%) and Democrats (62%)

According to the National Academy of Social Insurance:

71% of Americans want to expand Social Security benefits and pay for it by making millionaires and billionaires pay the same rate as the rest of us, and having everyone pay a little bit more.

The President has pledged to focus on what the majority of Americans sent him to DC to do.

If the President is standing with the majority of Americans against all cuts to Social Security, including the chained CPI, and standing for expanding benefits…

…then let’s stand with him:

I am going to start making blog posts to debunk this thought of the President’s about the need to get our fiscal house in order. It took me a while to finally come to realize the practicality of the Government taking back the sole power to create U.S. Money.

Fact-Checking Faux Noise on Obamacare

Crooks and Liars has the article Fact-Checking Fox: What Real Journalism Looks Like. The article starts with the following:

Ashley Dionne, a recent guest on Mike Huckabee’s show, claimed that her insurance premiums would jump from $75 per month to $319 per month for her family. She proclaimed the act to be the “Unaffordable Care Act” and went even further, claiming her future and that of her children had been ‘raped.’

Unfortunately, someone forgot to mention to Ashley that her premiums were offset with subsidies, so she would really pay $223 per YEAR as well as receiving assistance with copayments. Oops.

The story goes on to debunk all the other scare tactics used by the Ted Cruz’s of the world.  I was wondering if anybody would come along to put the lie to what the Republicans have been saying about the supposed harm that the ACA is causing.

I suppose it is true that anything as complicated as buying health insurance could be mistakenly interpreted by some customers.  So it may be true that if you get your noise from Faux Noise that the ACA won’t work for you.  Perhaps some of the other media will use their powers to clear up any misconceptions people might have.  For the people who get their news from these sources, the ACA will work for them.  I’d just love to see a study eventually done that shows just this, the ACA has a disproportionate failure rate for people who get their noise from Faux Noise.