Does Printing Money Create Debt or is it the Other Way Around?

Recently Sally Hutchins commented on a recent post as follows:

Please continue. So printing more money is creating more debt? Educate me. Love, Sally

Love? Yep. She’s my adorable sister.

Hi Sally:

Let me try to answer your question as succinctly as I can.

“Printing money” is a term used today that nobody really knows what it means. Historically it meant the government physically printed little pieces of paper which were then spent into circulation by buying goods and services the government needed. For example, in the Revolutionary War, the government printed continentals to pay the troops. Allegedly, British counterfieting rendered the currency eventually worthless. Again, when New York Bankers refused Abraham Lincoln additional financing during the Civil War, Lincoln then decided simply to print “greenbacks” to pay the troops. It worked. Merchants accepted greenbacks because Lincoln decreed that greenbacks would be accepted by the government for the payment of taxes. “Greenbacks” remained in circulation for decades and largely contributed to massive subsequent economic growth.

Today, 99 percent of all money in circulation isn’t currency at all, but mere electronic blips or signals recorded on the computerized ledgers of the banking system. Obviously actual printing of money doesn’t really happen anymore in any meaningful way. However, “money creation” is probably a more appropriate term. Money is created when a bank makes a loan. Presto. That’s it. I already know that you’re going to ask how that creates money if a bank just lends out money that someone else deposited with it. The answer is that the banking system can create new loans of up to 10 times the amount of deposits (reserves) that they must have on hand. At present, our banks are required to maintain cash reserves of 10% of its demand deposits. With a reserve requirement of 10%, the banking system may create new money of up to $1,000 from an initial deposit of only $100. It explains why a bank with over a Trillion dollars in loans can go bankrupt with losses of “only” 100 billion dollars. It’s called fractional reserve lending. How does it work? The Federal Reserve explains it this way:

Reserve requirements affect the potential of the banking system to create transaction deposits. If the reserve requirement is 10%, for example, a bank that receives a $100 deposit may lend out $90 of that deposit. If the borrower then writes a check to someone who deposits the $90, the bank receiving that deposit can lend out $81. As the process continues, the banking system can expand the initial deposit of $100 into a maximum of $1,000 of money ($100+$90+81+$72.90+…=$1,000). In contrast, with a 20% reserve requirement, the banking system would be able to expand the initial $100 deposit into a maximum of $500 ($100+$80+$64+$51.20+…=$500).
From the website of the Federal Reserve Bank of New York: http://www.newyorkfed.org/aboutthefed/fedpoint/fed45.html

Nifty huh? The problem arises, as I wrote in my previous post, when people and companies fearing future uncertainty don’t want to borrow or be in debt anymore and when banks fearing future economic uncertainty and loan defaults, don’t want to lend anymore. The reverse mutiplier effect kicks in and the money supply collapses as loans default or get paid off.

Because we’ve abdicated control of our money supply to a private banking system, nearly all of our money in circulation was created as a debt and, obviously, vanishes when the debt vanishes. We truly have no equity money, debt free money, such as Civil War era greenbacks, in circulation.

So in answer to your question, printing more money does not create more debt, it is debt that prints (creates) money. No more debt, no more money. The Fed and the administration are fit to be tied trying to create debt and money by keeping interest rates at zero and by spending humongous deficits, but it ain’t happenin’ very fast. There are Lincolnesque ways to do it, but none that are considered morally acceptable by the corrupt banking system which, candidly, veritably owns the congress and the administration and is not likely to give up their power and control over the money supply regardless of how much havoc they wreak on people and the economy.

And the banks — hard to believe in a time when we’re facing a banking crisis that many of the banks created — are still the most powerful lobby on Capitol Hill. And they frankly own the place.
Sen. Dick Durbin, April 29, 2009.

I hope this helps and didn’t confuse you more.

Thanks and love,

Joe

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One Response to Does Printing Money Create Debt or is it the Other Way Around?

  1. Jonathan says:

    Then isnt it all a wash? The more US treasury debt issued = more money printed. So why would it matter whether The US treasury prints bills directly or the Fed/central bank issues Federal reserve notes? The Reserve notes/electronic credits/debits function the same way as a US Treasury Note/coins would.

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