In May 2007, the Fed reported assets of about $850 billion, and 92% of them were the usual federal securities (government I.O.U.s). A year later, the Fed's stash of federal securities had dropped to $500 billion, but its total assets remained substantially unchanged. The federal securities had just been swapped for other forms of debt. In January of 2009, however, the Fed reported assets of $2.1 trillion, an increase of $1.2 trillion from a year earlier.3 Where did this new money come from? The Fed's liabilities also went up by $1.2 trillion, indicating that it was creating "credit" simply by double-entry bookkeeping. Loans were being created by entering them as assets on one side of the Fed's books and as corresponding liabilities on the other.
Creating money by double-entry bookkeeping is not actually unique to the central bank. It is how all commercial banks come up with the money they lend, as many authorities have attested. In a revealing booklet called Modern Money Mechanics, the Chicago Federal Reserve explained how banks expand the money supply (or create money) using double-entry bookkeeping. The booklet stated:
"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]."4
Congressman Jerry Voorhis, writing in 1973, explained how monetary expansion is built on the 10% reserve requirement imposed by the Fed:
"[F]or every $1 or $1.50 which people – or the government – deposit in a bank, the banking system can create out of thin air and by the stroke of a pen some $10 of checkbook money or demand deposits. It can lend all that $10 into circulation at interest just so long as it has the $1 or a little more in reserve to back it up."5
That means that if the Federal Reserve were operating like a commercial bank, it could take its $500 billion in U.S. securities and fan them into $5 trillion in loans; and that appears to be exactly what it has been doing. What is extraordinary is that the money is being used to make commercial loans. If the Fed can come up with $1.2 trillion to "monetize" private promissory notes, argues Ben Gisin, there is no reason it could not come up with $900 billion to monetize Obama's stimulus package. In fact, Congress could mandate its captive central bank to buy the bonds needed to fund the stimulus package.
The Advantage of Borrowing from the Federal Reserve
For the government, the difference between borrowing credit created with accounting entries from a private bank and borrowing the same sort of credit from the Federal Reserve is that borrowing from the Fed is nearly interest-free. That is true today, but it has not always been true. Congressman Wright Patman, Chairman of the House Banking and Currency Committee, wrote in a 1964 treatise called A Primer on Money:
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