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Which is More Inflationary, Government-Created or Central Bank-Created Money?

Ellen Brown is a strong voice for money-populism. She wants to replace the FED’s current powers with government (Treasury) control over the issuance of money. She would have the Congress authorize spending which would then be financed by the Treasury’s writing of checks as payments or equivalently having the FED issue bank credits as payments. The central bank would passively cash the checks for banks who received them from customer-depositors by issuing credits (bank reserves) to the banks. The FED would in essence be a bookkeeper that transmits the credits to banks as payments to whomever the Treasury is paying. The offsetting accounting entry on the FED’s books would be to debit a perpetual and non-redeemable and non-interest-bearing government “bond”. This procedure is tantamount to the Treasury printing up legal tender pieces of paper and mailing them to whomever the Congress designates as recipients. This is tantamount to helicopter money. In such a system, the fiscal-monetary distinction disappears. This is NOT the current legal system.

Ellen Brown and her followers want this new system. This is the system that Hugo Chavez created in Venezuela after taking office. This system resulted in hyperinflation in Venezuela. The legislature spent and spent and spent and it financed the spending by issuing unlimited bank credits. Since those credits are legal money or legal tender, the system produced helicopter money in large amounts and the Venezuelan hyperinflation, said to be anywhere from 500 to 1500 percent per annum. Once the central bank lost its independent role and was neutered, once it became a passive agent, once the Treasury became the money-issuer and stopped issuing real bonds and replaced them with a mere bookkeeping entry, then political pressures took over. It doesn’t matter whether the country has a dictator or a legislature or direct democracy or an elected popular leader. The pressures are to spend more and finance it by such helicopter money. That process is what creates hyperinflations and the worse losses in value of currencies. Populist systems that merge spending with money creation by letting the Treasury issue legal tender result in hyperinflationary helicopter money because they result in unlimited money issuance by the government. It is direct money creation and spending, both occurring at one and the same time. There is no limit to it. The same kind of result occurs if a central bank loses its independence and becomes a repository for valueless “bonds” issued by the government so that the government can obtain bank credits that it can spend. That is NOT the current system in most countries, including America. It is a good thing, meaning a non-hyperinflationary thing and a non-unlimited government spending thing, that we do not have such a system. The central bank system we have is not ideal by any means, but it’s hugely better than the Ellen Brown populist system, which unlocks all restraint on money issuance because of the inevitable political temptations and pressures to print money that it lets loose.

Every hyperinflation will be found to be one in which central bank independence was undermined and the Treasury became the money-issuer in fact, although there may have been bookkeeping or legal subterfuges to disguise this transformation. Right now, the U.S. government issues bonds of a definite maturity and definite interest rate, and it must collect taxes in order to be able to redeem them and pay interest. That’s a key part of the system. The currency’s value is supported by limits on money issue, and that’s supported by limits on government spending due to the necessity to collect taxes. Debt limits are fungible and always rise, but at least the debt needs to be paid off. The FED is independent in deciding how much of this debt it will absorb. If the markets come to believe that the FED will absorb unlimited amounts, then hyperinflation will result. A change in the system’s laws that enables Treasury power to issue money directly without having to worry about ever redeeming the bonds it creates as an offsetting accounting entry, such a change ends FED independence, ends the financing constraint on government-issued money and results in hyperinflation.

In 2007, well before the hyperinflation began in Venezuela, a newspaper article told us that Chavez “has proposed a change to the constitution that would allow unlimited presidential terms in Venezuela. The leader also told the National Assembly that he wanted to end autonomy for the central bank and bring its international reserves under presidential control.” Chávez said: “The international reserves of the republic will be handled by the central bank, under the direction of the president who is the administrator of the public finances.” Hyperinflation has been the consequence.

Government-created money, meaning directly created by the Treasury, is far more inflationary than central-bank created money. A Treasury issues the legal tender directly to the public. Political pressures are always present in any system in which government has a role in influencing the money supply. These pressures meet much-diminished barriers when the Treasury can legally issue money itself and directly to recipients. Everyone in the society can make a case for why they should be getting money. Any Treasury-money they receive is immediately and directly spendable by them. Central-bank created money is not immediately and directly spendable by the general public. Central-bank created money is in the form of bank reserves. The public cannot access bank reserves directly or spend them. We are talking about two kinds of different money in these two cases: Treasury money that’s like currency or cash and central-bank money in the form of bank reserves. The FED’s recent huge bond purchases have resulted in huge bank reserves. These can only be accessed by the public through another step, which is the process of loan creation by the banks. That will create deposits and ordinary money. The banks want to make good loans, not bad loans, so that they make profits and stay solvent. The managers want to hold onto their jobs. They do not make unlimited loans using available bank reserves. Besides, the FED pays interest on these bank reserves.

Ellen Brown wants to shift to hyperinflationary Treasury-issued money. Her arguments for doing this are all beside the main point which is that the result won’t be what she thinks it will be.

Libertarians should not be taken in by her use of “thin air” analogies or by the notion that she’d end the FED. What good does that do if it’s replaced by a system that’s worse? There are alternatives to the FED other than Treasury-issued money, a very bad populist kind of idea. There are other viable possibilities like free banking, removing restrictions and taxes on private money issue, computer-generated money and metallic-based money. In general, market-generated money stands at one pole in opposition to Treasury-generated money at the other pole. We are at neither pole at present. However, the pressures are building in American society toward Treasury-generated money. Populism turned loose on the monetary system will result in higher inflation and hyperinflation if the system is changed radically. Hillary Clinton’s proposals on the FED are in the populist direction. They are symptomatic of further movement in an already bad direction that was begun with the FED’s QE policies. “In a statement to The Washington Post, Clinton’s campaign said she supports removing bankers from the boards of directors and increasing diversity within the Fed.” These changes reduce the central bank’s independence. They result in greater political influence within the central bank. They result in pressures exerted by the central bank on member banks to issue more loans of questionable credit quality. Clinton’s recommendations are populist in the sense of shifting money-creation control to the government as agent for selected groups within society. They shift the system more toward the Treasury-money pole.

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8:34 am on August 7, 2016