Sustainable Government: Banking for a "New" New Deal

“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 45th 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.

The Key to a Solution:  Understanding Money and Credit

Jefferson realized too late that the Founding Fathers had been misled.  He wrote to Treasury Secretary Gallatin in 1815:

“The treasury, lacking confidence in the country, delivered itself bound hand and foot to bold and bankrupt adventurers and bankers pretending to have money, whom it could have crushed at any moment.”

He wrote to John Eppes in 1813:

“Although we have so foolishly allowed the field of circulating medium to be filched from us by private individuals, I think we may recover it.... The states should be asked to transfer the right of issuing paper money to Congress, in perpetuity.” 

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].”