Who Creates Money and Where Does It Go?

According to the Federal Reserve $1.5 trillion in newly created money was added to our money supply between 2014 and 2016.  With so much money around, why isn’t it available for better streets, roads and bridges? Why isn’t it available to city and rural school districts to provide their children with good schools?  Why isn’t it available to maintain Medicare and the Social Security system without the threat of their running out of money?

This lack of availability of money for such things is especially puzzling because money is simply information.  95% of our money exists only as numbers stored in computer accounts.   Even though we often think of money as cash, bills and coins make up less than 5% of the money in circulation.  We aren’t paid with cash and we don’t pay our bills with cash.  We use debit or credit cards, or checks or online debits, not cash.  Nearly all spending is an information transaction: it moves numbers between accounts in computers.

What is the source of this information that makes up most of our money?  Where does 95% of all money out there come from?  Most people think the government creates money, but that is true, at most, only of the 5% of our money that is made up of bills and coins.  Where did the rest—all this information in accounts—come from?  How was it created?

It comes from banks.  Money is created when a bank adds numbers to an account in the process of making a loan (see, for instance, Modern Money Mechanics, The Federal Reserve Bank of Chicago, available on-line).

We typically think that when a bank makes a loan, it transfers funds from its own deposit accounts to the borrower’s account, simply moving money from one place to another, rather than creating new money. But this is not what happens.  Instead, there is an accounting trick that only banks are permitted to use.  In making the loan, the bank simply enters the amount of the approved funds into the borrower’s checking account just as we would update a computer file. By increasing the balance in the borrower’s bank account by the amount of the loan, the bank creates a deposit equal to the money loaned. It does this simply by typing numbers into a computer.  The bank’s own assets are not reduced by the loan.  This accounting maneuver enables the bank to create new money out of nothing.  This is how new money enters our economy.  It is through this process that most of $1.5 trillion in new money created between 2014 and 2016 entered the economy.   It was created as debt or, as the banks like to call it, as “credit.”

The system of creating money as debt when banks make loans means that all of the money circulating in the economy is on loan.  Interest is being paid to the financial sector on every dollar in circulation.  This results in a systematic transfer of wealth from the many (the borrowers) to the few (the lenders).  This transfer is a primary contributor to the concentration of wealth in the financial sector.

This helps us understand why money isn’t available for so many needed projects despite there being so much of it circulating in the economy.

Because new money is generated by banks, banks get to determine where the money goes. It goes toward their profit-making.  Banks only fund projects capable of generating returns in the form of principal and interest payments back to the banks.  It doesn’t go to building or repairing roads, unless the government borrows the money from the bank or from another source. The loan, plus interest, then has to be repaid to the lender out of the pockets of taxpayers now and in future generations.

Article 1, Section 8, of the US Constitution gives Congress the authority to create new money.  Congress has failed to use this authority and instead has given it to banks. Instead of creating new money to be spent on roads, schools, or other needed projects—which it has the authority to do—government borrows the money and pays it back plus interest. The payment of interest on the federal debt is the third largest expenditure in the federal budget.  Wouldn’t we be better off having the government create the money it spends rather than borrowing it, and then taxing us to pay the lenders principal plus interest?  The existing debt-based method of government spending, like debt-money creation itself, constitutes a systematic transfer of wealth from the many, the borrowers (taxpayers), to the few (lenders).

If the monetary system worked as most people think it works, things would be radically different.

Most people think that the government does create the money.  But it doesn’t. If the government did create the money it spends, then there would be no federal debt.  If the government created the money it spends, then there would be funds available for the projects we want it to undertake.  If the monetary system worked as most people think it works, banks would loan only the money they actually have, like other lenders do today, rather than create new money as they make loans. New money created by government, would go to the physical and social infrastructure required for a healthy and sustainable economy.  Under the current system, new money created through lending by banks, especially the large, Wall Street banks, often goes into speculative investment instead of productive projects.  Newly created money has to go into our growing economy in some fashion.  Right now, banks perform that function despite the fact that our Constitution assigned it to the federal government.

It is time to make our monetary system work the way we actually think it works.

A system of money created by government served well in colonial America and during the Civil War. It can work now to meet the country’s acute needs of a decaying infrastructure, the lethal threat of climate change, the rising costs of health care, Social Security, and quality education, and many other pressing needs.   Legislation, the National Emergency Employment Defense Act, was introduced into Congress in 2012 to reform the monetary system and needs to be reconsidered at this time, in order to put us on a course to real recovery, security, and a sustainable future.

From the Athens Monetary Literacy Group: John Howell, John Glazer, Warren Haydon, Dick McGinn, Jim Phillips, and Candida Stamp.

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