No Free Lunch: Economics for a Fallen World: Third Edition, Revised

Chapter Eleven: Money, Money, Money! 263 which is a liability to the bank, and is seen in the right hand column of Figure 11.4 . However, they have my guarantee to pay back the loan, which is an asset in their loan portfolio (seen in the left column). The sum of the change in their assets and liabilities equals zero, so it’s easy for an individual banker to think he or she didn’t create any money; but there is now $1,000 purchasing power in the economy that wasn’t there before, while the physical goods and services in the economy haven’t changed. While it’s true that the assets and the liabilities balance, notice that the checking account gives me purchasing power today, while I only have to pay back purchasing power in the future! It is this element of time that causes the problem. Let’s mentally think through what would happen if I asked for (and received) a $22 trillion loan. Yes, it’s absurd; but the absurdity will illustrate the point. When the bank credits my account with $22T, there is now twice the purchasing power as the economy previously had, but no additional goods and services. It should be obvious that when I try to spend the $22T, along with the rest of the U.S. economy’s $22T (approximately equal to the 2019 annual U.S. output), that twice the dollars chasing the same amount of goods is going to lead to significant inflation. The price level will roughly double in the final equilibrium (we will ignore any changes due to expections and how much cash people are willing to hold in an inflationary environment). THE FEDERAL RESERVE AKA “THE FED” The Federal Reserve is the central bank of the United States of America. Most countries have a central bank; ours is simply known as the “Fed.” The Fed is the banker’s bank, but also the U.S. government’s bank. Created in 1913, the Fed is delegated responsibility for monetary policy by the U.S. Congress, but it is not an official agency of the U.S. government. The Federal Reserve consists of 12 regional banks, but the real policy is decided by its Board of Governors. The members of the Board of Governors are all appointed by the President and confirmed by the Senate. The private banks are represented with rotating voting positions on the Fed’s monetary policy committee, the Federal Open Market Committee , but the political appointees outnumber them. Many people are concerned that the Fed is actually owned by private banks. Most economists are much less concerned about who owns the Fed than with the ill effects of the Fed’s policies. The Fed enables all banks to expand their balance sheets significantly faster than a free banking system would, which results in higher consumer prices. Further, many critics suggest that the Fed has done more damage than it has helped , and indeed, there is consensus among economists that the Fed at least exacerbated the Great Depression (if not causing it outright) and the Fed was certainly at least complicit in the 2008-2009 financial crisis with their easy money policy enabling the mortgage bubble. $1000 $1000 Loan Checking Account Assets Liabilities Bank T-Account Figure 11.4, Bank T-Account. When a bank loans $1000 to a customer, they create a liability of $1000 by depositing $1000 in the customer’s checking account. At the same time, they have an asset in their loan portfolio of $1000. The sum of their assets and liabilities equals zero, so they think, “What new money?”