Does the federal reserve create money out of “thin air” as Ron Paul and others have suggested?
Is this really true? Or is this an exagerated myth?
If this is true, how exaclty does the federal reserve create money out of “thin air”?
“Out of thin air” meaning they simply decide to print more money and fires up the printers. The phrase “out of thin air” is used to show that the creation of new money is an arbitrary decision, as well as putting ink on paper and saying “look, new money!”
If this is true, how exaclty does the federal reserve create money out of “thin air”?
All banks create money out of thin air. Exactly what the Fed does on its books, Im not sure, but regular banks simply make ledger entries on its balance sheet when loans are made and this creates money. I would imagine that the Fed does something similar.
I’m not sure anyone knows exactly what the Fed does or how it does it and this, I beleive, is part of what Ron Paul is trying to do. Get the Feds books made public so that everyone can see exactly how they are doing what they do.
example
if the federal reserve wants to increase the money supply by 1 million dollars they purchase 1 million dollars worth of government securities from bank of america. in turn bank of america gets a check for 1 million dollars.
but bank of america still had to give up 1 million dollars worth in government securities. So, bank of america gained 1 million in dollars, but gave up 1 million in government securities. Did they really gain anything?
Where did those government securities that bank of america sold to the fed come from in the first place? Did they not cost them 1 million dollars?
In your example Bank of America essentially gave up future cash for present cash. It’s only better off in the sense that it preferred cash now to cash later. If you look at the Fed’s side of the equation, they gave up $1 million they didn’t previously have (they created it out of thin air) and gained $1 million in government securities. Thus the money supply increases by $1 million.
Furthermore, Bank of America now has an extra $1 million on which it can pyramid credit through fractional reserve banking. If the reserve requirement is 10%, the maximum the banking system will be able to create is $9 million.
So if this process plays out, the total amount of new money created by the Fed’s purchase of $1 million of government securities will be $10 million.
“If you look at the Fed’s side of the equation, they gave up $1 million they didn’t previously have (they created it out of thin air) and gained $1 million in government securities.”
That is true. Ok, I see now.
Question, what exactly does the fed then do with the 1 million in government securities?
The FED holds onto them, lets the securities/debt roll over and wait until they feel there is too much money, then sell them back to BoA
It actually means that the printing presses they use are located at a high altitude
“Out of thin air” meaning they simply decide to print more money and fires up the printers. The phrase “out of thin air” is used to show that the creation of new money is an arbitrary decision, as well as putting ink on paper and saying “look, new money!”
I beleive that the phrase “creates money out of thin air” is literally what is done. Banks do this every time a loan is made… every single day.
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Assets |
= |
Liabilities |
|
Equity |
||
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US Gov. Debt |
Other Banks Debt |
US Gov Deposits |
Other Bank Deposits |
Fed Equity Acct. |
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|
Begin |
$1,000,000,000 |
$1,000,000,000 |
$500,000,000 |
$1,000,000,000 |
$500,000,000 |
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Above is the starting Fed balance sheet. The US Gov. decides to issue $100,000,000 million in treasuries. The Fed will buy $750,000,000 of those treasuries. |
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Assets |
= |
Liabilities |
|
Equity |
||
|
US Gov. Debt |
Other Banks Debt |
US Gov Deposits |
Other Bank Deposits |
Fed Equity Acct. |
|||
|
Begin |
$1,000,000,000 |
$1,000,000,000 |
$500,000,000 |
$1,000,000,000 |
$500,000,000 |
||
|
$750,000,000 |
$750,000,000 |
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End |
$1,750,000,000 |
$1,000,000,000 |
$1,250,000,000 |
$1,000,000,000 |
$500,000,000 |
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The ledger entries would appear as the following. The Fed increases its assets in the US Gov Debt account by $750,000,000. It then balances that entry by increasing it Liabilities in the US Gov Deposits account. |
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Assets |
= |
Liabilities |
|
Equity |
||
|
US Gov. Debt |
Other Banks Debt |
US Gov Deposits |
Other Bank Deposits |
Fed Equity Acct. |
|||
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End |
$1,750,000,000 |
$1,000,000,000 |
$1,250,000,000 |
$1,000,000,000 |
$500,000,000 |
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At the end of the trasaction the Fed has just created $750 million out of thin air. No printing presses required, no arbitrary decision… Just account entries. Our entire banking system is based on the above. |
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Now the accounts might be called something different, or they might have 2 or 3 sets of books that they use to track all they do but the essences would remain the same. Ledger entries… nothing more.
The Fed controls the size of the monetary base. It can increase it (print money) or decrease it (burn money). This is part of its charter, it’s not a “claim” by Ron Paul or anyone else.
Clayton -
Yes, the Fed creates money out of thin air. It is not a claim. That is exactly what open market operations, and now quantitative easing, are.
In the example above, the Fed writes a $1 million check to a bond dealer to buy bonds. When the dealer deposits the check, a $1 million demand deposit appears out of nowhere, it did not exist before, it is created from nothing. The money supply increased by $1 million.
When the dealer originally loaned the money to the US Gov’t, an existing demand deposit was transferred from the dealer to the government. No change in the money supply occured.
But when the Fed bought the bond from the dealer, the Fed used a very special type of check that only it can write. New money is created when the check clears.
If you or I tried this trick, we would be arrested for writing bad checks. When the the Fed does it, it is called “monetary policy”.
Imagine if you had no money, but could write a $1 million check to buy a house, and the banking system honored your check, and the government is pleased that you are providing “accommodation” to the real estate market.
It should be obvious that you just created $1 million that did not exist prior to your purchase. That is exactly what the Fed does (except it normally buys treasuries, MBS’s, CMBS’s because the bond market is one of its clients. Its other clients are the banking system and the U.S. Government).