The Fed’s 1.6 trillion ‘somethings’ | FT Alphaville

The Fed’s 1.6 trillion ‘somethings’

Chris Cook, strategic market consultant, entrepreneur and commentator, likes to push boundaries when it comes to financial thinking.

He’s at it again on Tuesday in the Asia Times. This time questioning the world’s current understanding of what bank money is.  Also, how it relates to quantitative easing.

So what’s at issue?

It all revolves around Ben Bernanke’s quantitative easing — and especially with regards to the traditional understanding of how an economy works via tax and spend.

That is, ordinarily wealth is produced, taxed and then re-distributed back into the economy.

The tax is only the means by which that wealth, which has already been created, is redistributed.

But as Cook notes:

The tax and spend myth is that “tax-payers’ money” is first collected by the Fed and then spent, or lent.

Bernanke blew that one away when he told the committee that taxpayers’ money was not involved when the Fed was busy easing quantitatively. The Fed created 1.6 trillion somethings, which banks accepted, either for their own account or a customer’s account, in exchange for the Treasury Bills they owned, and these somethings were, and still are, deposited with the Federal Reserve Bank as a custodian of … “reserves”.


Bernanke confirmed the staggeringly simple reality that not a single taxpayers’ dollar is actually spent or lent when the Fed follows the Treasury’s instructions to credit any account, anywhere, for anything. This is because the Fed is creating – as an agent on behalf of the Treasury – an exact “look-alike” of a Treasury IOU or promissory note. ie the Fed is simply pledging the Treasury’s credit by creating tax credits.

The point here is that based on the tax and spend model, paying a tax of $1 is the equivalent of seeing $1’s worth of tax canceled by the Fed as agent for the Treasury. The national debt goes down by $1.

Or as Cook puts it:

It’s exactly as though an obsolete $1 note is torn up or burnt. Or another way of looking at it is that it is what happens when a Frequent Flyer Mile is redeemed against a flight.

Because the money everyone is paid is nothing more than a tax credit, there’s only one problem. It comes about when the number of tax credits issued outnumbers the total redeemable wealth of the nation (i.e. the tangible common equity of the nation is fully eroded). That’s clearly not the case in the United States.

Bernanke’s QE ‘somethings’, meanwhile, are just like-for-like tax credits, thus also a form of equity, not debt. Or as Cook explains a type of preference share:

…they are for all the world equivalent to a $1.00 redeemable preference share issued by US Incorporated. When the Fed creates these tax credits on behalf of the Fed it creates an asset – not a liability – that it holds in reserve as custodian for the recipient banks as a “deposit”.

He goes on:

US dollar “fiat currency” is not a debt of the Fed: it is simply a tax credit that is created and spent by the Fed on Treasury instructions. “Taxpayers’ money” has in truth never been anywhere near a tax-payer. This myth of tax and spend arises out of credit creation by the central bank. The myth of fractional reserve banking arises out of credit creation by private banks.

We like to think of it as fiat currency being a credit backed by a country’s taxable wealth. The taxable wealth of the nation (including GDP) is the collateral.

The critical point to keep in mind then is that “money” isn’t created out of thin air. The money (or tax credit) is not the loan.  It’s just the ‘something’ —  representative of taxable wealth — which is created to be loaned (or passed around) at a chargeable rate. And any banking institution can do it.

The same applies on a national level — meaning the US debt may not exist at all. It’s actually a fiction.

As Cook explains:

…it is a national equity, the greater part of which is interest-bearing either as claims over public or private revenues.

At least two-thirds of the quasi tax credits created by banks came into existence as mortgage loans, and are therefore backed by claims over the productive value of the US land and buildings which they fund. Much of the rest consists of claims over the value of US assets which fund the productive capacity of US corporations. The remainder – which provides the credit necessary to finance the circulation of goods and services in the US – is based upon the magnificent productive capacity of the US people.  Only by liquidating US Incorporated could this National Equity ever be redeemed.

Given that, the debt ceiling could arguably be considered a myth as well.

After all the dilution of the “share” doesn’t impact the overall market capitalisation. It just means more people can make use of the wealth of the nation. The credit units (or outstanding shares) are just a facilitator for the distribution of that wealth.

In which case the way out of the debt conundrum is not by restricting the creation of more shares, as is being debated, but by focusing on collectively building up the equity instead.

As Cook concludes:

President Barack Obama and his government should get busy creating national equity by instructing the Fed to create and issue the necessary finance for the creation of a new generation of US infrastructure; the transition to a low carbon future which the US can, and should, be leading; and in increasing the capacity of the US people to do so.

Related links:
Raid Fort Knox!… and other debt ceiling solutions – FT Alphaville
The impossible debt ceiling rollover
– FT Alphaville