The Crash Course - Chris Martenson [28]
So where does the money come from to pay back the interest? And where did that original $1,000 come from? We can clear up both mysteries by traveling to the headwaters of the money river.
The Fed
Even though you might have gotten a loan from Bank of America, creating money in the process, the dollars you received don’t say “Bank of America Note” on them; they say “Federal Reserve Note.” To find out where all money originally comes from, we need to spend a little time understanding how the Federal Reserve creates money.
Chartered by Congress in 1913 to manage the nation’s money supply, the Federal Reserve (a.k.a. “the Fed”) has complete and unilateral discretion to decide when and how much money is made available to the banking system, and by extension the entire economy.
But the Fed doesn’t just print up a bunch of money and send it out in trucks; it lends the money into existence. After all, it is a bank. The process works like this: Suppose the U.S. government wishes to spend more money than it has. Perhaps it has done something really historically foolish, like cutting taxes while conducting two wars at the same time, and finds itself short of money.
Now, having abdicated its monetary responsibilities to a third party (the Fed), the U.S. government can’t create any money, so the request for additional spending money by Congress gets routed through the Treasury Department, which, it turns out, rarely has more than a couple of weeks of cash on hand (if that) already earmarked for spending that was put into motion months or even years ago.
So in order to raise the desired cash, the Treasury Department will print up a stack of Treasury bonds (or bills or notes, which are essentially all the same things with different maturities). A bond has a “face value,” which is the amount that it will be sold for, and it has a stated rate of interest that it will pay the holder. So if you bought a bond with a $100 face value that pays a rate of interest of 5 percent, then you would pay $100 for this bond but get $105 back in a year, representing your original $100 plus $5 in interest.
Treasury bonds, bills, and notes are sold in regularly scheduled auctions and are mainly purchased by banks, other large financial institutions, or the central banks of other countries. So if a batch of bonds with a face value of $1 billion is sold at auction, then that $1 billion lands in the Treasury’s coffers, where it is then available to the U.S. government to spend. Assuming these are Treasury Notes with a one year maturity, in a year the Treasury Department will return all $1 billion to the purchasers of those bonds, plus an amount equal to whatever the rate of interest happened to be.
So far no new money has yet been created. Treasury bonds are bought with money that already exists. The question remains, Where does new money come from?
New money, a.k.a. “hot money,” comes into being when the Federal Reserve buys a Treasury bond from a bank. When the Fed does this, it simply transfers money in the amount of the bond to the other bank and takes possession of the bond. The bond is swapped for money.
But where did that money come from? It was created out of thin air, as the Fed literally creates money when it “buys” this debt.
Don’t believe me? Here’s a quote from a Federal Reserve publication titled “Putting it Simply”:
When you or I write a check, there must be sufficient funds in our account to cover the check, but when the Federal Reserve writes a check, there is no bank deposit on which that check is drawn. When the Federal Reserve writes a check, it is creating money.5
Now that is an extraordinary power. Whereas you or I need to work (i.e., expend human labor) to obtain money, and then place it at risk to have it grow, the Federal Reserve simply prints up as much as it deems prudent and then loans it out, with interest.
The answer to how money originally comes into existence