By John Titus
In order to fully understand how the Federal Reserve implemented BlackRock’s “going direct” plan and how central bank digital currencies (CBDCs) pose a threat to national sovereignty, one needs a basic understanding of a few monetary ideas that are not widely known despite (or perhaps because of) their importance. To that end, we are providing this short primer on the U.S. debt-based monetary system.
As an initial matter, it’s helpful to know that there are four different types of money still issued in the United States:
- Coins are physical money created and issued by the U.S. Treasury and sold at face value to the Federal Reserve, which books coins as an asset on its balance sheet; unlike the other three forms of money, coins are issued without any corresponding debt attached to them; coins are legal tender, meaning that they can be used to pay “all debts, public charges, taxes, and dues.” 31 U.S.C. § 5103.
- Cash (Federal Reserve notes) is physical money issued by the Federal Reserve (though created by the Treasury’s Bureau of Engraving and Printing at the Fed’s instruction) and sold by the Fed at face value to commercial banks, which pay for cash using their reserve accounts at the Fed, which get debited in the amount of cash obtained; cash is one of two liabilities on the Federal Reserve’s balance sheet, and an obligation of the U.S. government; cash is legal tender, meaning that it can be used to pay “all debts, public charges, taxes, and dues.” 31 U.S.C. § 5103.
- Reserves are electronic money created and issued by the Federal Reserve in exchange for U.S. government bonds and bills (i.e., IOUs from the U.S. government); reserves are the second liability on the Federal Reserve’s balance sheet, but reserves are assets to commercial banks and other entities that bank with the Fed, including the U.S. government and foreign central banks; reserves (i.e., Fed liabilities or IOUs) are money only for these entities, and exist only as the result of government debt; the amount of reserves in the system is controlled by the Federal Reserve, which increases reserves by buying government bonds (or agency mortgage-backed securities) and decreases reserves by selling government bonds (or agency mortgage-backed securities); reserves are not legal tender.
- Bank money is electronic money created and issued by commercial banks in exchange for debt, public or private, taken on by borrowers from the bank, whose electronic accounts at the bank are credited in the amount of their new loan; bank money is a liability to commercial banks but is an asset to non-bank entities who bank at commercial banks, including people, non-financial businesses, non-bank financial businesses, and governments—bank money (i.e., a commercial bank liability or IOU) is money for these entities; the amount of bank money in the system is controlled by commercial banks, which increase bank money by buying debt (crediting bank accounts in exchange for loan paper) and decrease bank money by not issuing new debt as old debt gets paid off; bank money is not legal tender.
By way of that background on types of money, three basic concepts are helpful if not critical to understanding both BlackRock’s “going direct” formulation implemented by the Federal Reserve in 2020 and how CBDCs are likely to evolve in a way that will jeopardize U.S. sovereignty.
(1) Money creation is a sovereign power (regardless of whether or not the sovereign’s legal authorities understand that fact).
(2) Debt-based money gives the money issuers control of the money supply (and thus the economy).
(3) In the United States, there are two distinct tiers of debt-based money issuance—commercial banks and the Federal Reserve.
(1) Money Creation and Control Is a Sovereign Power
The critical nature of monetary creation and control to the sovereignty of national governments was well understood at one time even if it is not well understood now.
- The inability of the Colonists to get power to issue their own money permanently out of the hands of George III was the prime reason for the revolutionary war. —Ben Franklin
- The Government should create, issue, and circulate all the currency and credits needed to satisfy the spending power of the Government and the buying power of consumers. By the adoption of these principles, the taxpayers will be saved immense sums of interest. Money will cease to be master and become servant of humanity. —Abraham Lincoln
- Until the control of the issue of currency and credit is restored to government and recognized as its most conspicuous and sacred responsibility, all talk of the sovereignty of Parliament and of democracy is idle and futile. —William Lyon Mackenzie King, Canadian Prime Minister, 1935
The fact that money creation is inextricably bound up with national sovereignty is reflected in the U.S. constitution, which provides that “the Congress shall have Power… To coin Money, regulate the value thereof, and of foreign Coin, and fix the Standard of Weights and Measures…” (U.S. Const., Art. 1, §8, cl. 5).
Coins are actually the only form of money issued in literal accordance with the constitution, that is, by a governmental entity representing (at least on paper) the constitutional sovereign of the United States, which of course is “we the people.” All other forms of money—cash, reserves, and bank money—are issued by private banks.
Moreover, these three forms of money cannot exist without the parallel creation of debt. All of this money, in other words, must be borrowed into existence. But for the existence of coins, which are issued by the sovereign government, the U.S. monetary system would be completely contrary to the constitution, which vests “we the people”—not a small group of bankers—with the power of money creation. Even more fundamentally, the U.S. monetary system flouts the rule of law in that rather than providing for equality under the law, the U.S. legal system instead installs and secures two legal classes of people: creditors (the tiny few) who create money out of thin air and lend it out at interest, and borrowers (the vast majority), who depend on creditors for their money and must pay them for the privilege of using it despite the fact that those creditors create the money out of thin air.
(2) In the U.S., the Money Supply Is Controlled by Private Banks
As noted, cash, bank money, and reserves are all issued by private banks.
Cash is a physical form of money issued by each of the 12 private regional Federal Reserve banks1 and is labeled as such (i.e., as “Federal Reserve Notes”). As noted, the Fed issues cash when a commercial bank pays for it with reserves in its reserve account at the Fed. Thus, the amount of cash in the system is determined by private banks.
Reserves are an electronic form of money created and issued by the Federal Reserve in exchange for debt securities like U.S. Treasuries. Reserves are a liability on the Federal Reserve’s balance sheet, with the corresponding asset typically being a government bond. Legally, reserves are IOUs from the Federal Reserve to any entity having an account at the Fed, into which reserves can be deposited. Ordinary people and businesses—even non-bank financial businesses—do not have accounts at the Federal Reserve. Reserves are thus not money for ordinary people and businesses, nor are they money for the Fed itself. Reserves serve as money only to account holders at the Federal Reserve, mainly commercial banks. As such, reserves are assets on the balance sheets of commercial banks and (as noted) liabilities to the Federal Reserve.
Bank money is an electronic form of money created and issued by commercial banks. Bank money is a liability on the balance sheets of commercial banks. Legally, bank money is an IOU from a commercial bank to its customers (i.e., to people and businesses that have an account with the commercial bank). Bank money is thus not money to the Federal Reserve (which doesn’t maintain accounts at commercial banks), nor money for the commercial banks themselves. Bank money serves as money only to account holders (who treat bank money as an asset), but functions (as noted) as a liability to commercial banks.
The upshot here is that with the exception of coins, all money in the U.S. is created only with the issuance of debt, and the money supply in the U.S. is controlled completely by banks. That stems from the fact that IOUs and thus money are destroyed when loans are paid off. Consequently, bankers can shrink the money supply simply by not making new loans as outstanding loans get paid off—a process that can be accelerated by calling outstanding loans ahead of schedule. It is this feature of our monetary system that gives bankers near-total control in the U.S.
This is a staggering thought. We are completely dependent on the Commercial Banks. Someone has to borrow every dollar we have in circulation, cash or credit. If the Banks create ample synthetic money, we are prosperous; if not, we starve. We are, absolutely, without a permanent money system.
(“Foreword by a Banker” by Robert Hemphill, former Credit Manager, Federal Reserve Bank of Atlanta, in: 100% Money by Irving Fisher, Adelphi Company, 1935.)
For proof that commercial banks create money out of thin air whenever they make loans, see “Mommy, Where Does Money Come From?” (S1 E4).
(3) In the U.S., There Are Two Separate Tiers of Electronic Money
As discussed above, electronic money in the U.S. comes in two different forms that are in a very real way opposite forms, too—bank money (issued by commercial banks) and reserves (issued by the Federal Reserve).
From the point of view of a commercial bank, bank money is a liability (legally a promise from the bank to pay a depositor), while reserve money is an asset (an IOU from the Fed to account holders like commercial banks).
Not surprisingly, the confusion generated by the fact that a dollar can take on opposite “polarities,” depending on whether it was issued by a commercial bank or the Fed, is essentially endless. Thus it is we often hear people speaking of banks as motivated to “steal deposits,” when the reality is that banks have just the opposite incentive—to reduce deposits—since money in deposit accounts is a bank liability. Likewise, people speak of banks lending out reserves even though doing so is impossible.
For a demonstration of why reserves are necessary in our two-tiered monetary system at all, see “Wherefore Art Thou Reserves?” (S3 E1) starting the 20:00 mark. For an in-depth discussion of the split-circuit monetary system, see chapter 4 of Sovereign Money (2017), by Joseph Huber.
The takeaway here is that whenever the discussion involves the Federal Reserve, which can only issue reserves (to account holders at the Federal Reserve) and cannot issue bank money, one must remain cognizant of the fact that in the “real world,” reserves appear as assets on commercial bank balance sheets as a counterbalance to our money, which from the point of view of the banks is a liability.
This leads to the second key insight here. Commercial banks can be used to “convert” reserves into bank money for a non-bank seller of an asset by way of a three-way transaction: (1) Fed buys asset from non-bank seller by depositing reserves into the commercial bank of said seller; (2) commercial bank of seller books reserves as asset and creates equal amount of bank money, depositing it into seller’s account; and (3) seller tenders asset to Fed and gets paid via new deposit money on account with commercial bank. This is precisely how the Federal Reserve expanded its balance sheet (reserve money) by $3 trillion in 2020 at the same time that it caused the expansion of the bank money supply by $3 trillion.
The relationship among the Federal Reserve, commercial banks and commercial bank customers (people and non-bank businesses) is depicted in the following frame taken from “Quantitative Easing Is the Biggest Sham Ever” (S3 E2).
Starting from the right, Nullity Group’s $1400 balance sheet includes a $300 asset in the form of a bank account (illustrated by three red marbles) at Jolly Jester Bank. This illustrates the fact that our money in bank accounts, while an asset to us, is actually a liability to the bank.
The same asset-liability relationship obtains the next tier up: Jolly Jester’s $400 reserve account, while an asset to Jolly Jester Bank, is a $400 liability to the Federal Reserve, indicated by white marbles.
The differently colored marbles indicate different “polarities” that money takes on in a debt-based monetary system. Each $100 of bank money is represented by a red marble, indicating that it is a liability to commercial banks—a $100 IOU from a commercial bank to its customer. A white marble represents $100 as well, only in this case it is a liability of the Federal Reserve—a $100 IOU from the Fed to its commercial bank customer.
This structure is directly relevant to how the Federal Reserve expanded its balance sheet during the pandemic: by purchasing assets from non-banks, the Federal Reserve with each (say) $1 billion purchase using reserves (the only money that the Fed can issue) forced commercial banks to create $1 billion in bank money. The parallel creation of bank money is necessary both to compensate the non-bank asset seller and to balance the books of the commercial bank that was credited with $1 billion in new reserve money (an asset) and thus needed a countervailing $1 billion liability.
That structure should also be kept in mind with CBDCs.
Under the current system, reserves (white marbles) are needed for commercial banks to settle transactions between commercial banks (conducted with red marbles). If Customer 2 from Bank B pays Customer 1 from Bank A with $100 electronically, Bank B ends up deleting a $100 liability from its balance sheet (when Customer reduces his account by making the payment), and Bank A ends up taking on the $100 liability (by crediting Customer A’s account). For this transaction to go through—for settlement to take place, so Bank A isn’t left in the lurch and Bank B doesn’t get a $100 windfall—Bank B must transfer a $100 asset to Bank A to counterbalance the $100 liability being shifted from B to A. Bank B does this by transferring $100 in reserves to Bank A.
With CBDCs, however, commercial banks are eliminated. The diagram above must be modified by removing the center column. In all discussions of CBDCs by central banks, the liabilities of the Fed will include accounts for each user of the Fed’s CBDC, with the corresponding asset on the Fed’s balance sheet being a U.S. government bond.
Under this system, CBDCs would represent liabilities of each central bank, assuming the role of red marbles. It is thus foreseeable that payments would be made between residents from two different central bank jurisdictions, but wouldn’t net out to zero, as is the case now with customers from different commercial banks. Thus, to settle net imbalances from different central bank jurisdictions, it is likewise foreseeable that a new global reserve currency would be needed—just as central bank reserves are needed now to settle net imbalances between commercial banks.
In that event, the new global reserve currency would occupy a superior legal footing to the CBDCs that require settling. In such a system, the U.S. dollar would be on equal footing with other central bank currencies, and its position as world reserve currency supplanted by perhaps a basket of currencies or special drawing rights (SDRs) or the like from, say, the Bank for International Settlements (BIS).
But that is a story for another day.
1 For proof in the form of admissions from the New York Fed that all 12 regional Federal Reserve banks are private rather than governmental institutions, see “The Federal Reserve – Kicking People When They’re Down” (S2 E2).