Modern Money Part III

Keith Evans
4 min readDec 25, 2020


Bank money and its place in the big picture.

To this point, I have addressed money as defined by our monetary system as a tax credit. The federal government will only accept its own currency in payment of tax obligations as it is those obligations that create the demand for the currency and allow for the government’s management of the money supply. However, the government has not restricted the creation of “money” to itself. In fact, those grocery coupons you clip from the prolific amount of junk mail most of us detest are a form of money. They offer a guarantee of redemption with an assigned value as long as you comply with the terms of the contract. It is no surprise that our banking system would get onboard this system with their own form of money.

It is commonly thought that banks take deposits from savers and loan them to qualified borrowers, but this is in error, and actually isn't even operationally possible. Banking is split along very defined lines between savings and loans, and never the twain shall meet. Savings deposits at a bank are convertible to cash, so they must represent a portion of the government-issued money in the system. Loans, on the other hand, only represent the superior good faith and credit of the bank and are 100% offset with contracts to repay entered into by individuals and companies the bank has deemed “creditworthy” and no real money holding of the bank is necessary to enable it to make loans.

When a borrower takes out a loan from his/her bank of choice the proceeds of that loan are created “from thin air” by the Federal Reserve and loaned to the bank at the base (overnight) rate of interest. This makes the reserves created by the Fed an “obligation” to the bank, not an asset as most people believe. As the borrower pays down the principal of the loan the bank retires an equal amount of its reserves to lower its interest cost and keeps any interest paid by the borrower as its profits. This is the only way to enable the interbank transfers of loan proceeds that result from the original borrower spending those proceeds into the economy.

How it all fits together.

The indebtedness of banks and the percentage of the total money in circulation it represents is many times that of our government’s debt, in spite of the “hair on fire” attention the national debt receives from politicians and the general public. What differentiates that indebtedness from our national debt is the fact that only money created by Congress deficit spending can net retire bank debt without the creation of new debt. Should the politicians ever seriously consider actually balancing the nation’s budget between taxation and spending it would leave nothing in the economy to represent the resources and labor it uses and would cause the private sector banking system to encounter massive default risk.

The only way to avoid such risk in the private sector, in the absence of any political will to fund the economy with money creation, is to maintain a constantly increasing GDP that effectively “rolls over” private sector bank debt instead of retiring it. Anytime that increase slows, even in the slightest, the economy takes a dive and people are forced into involuntary unemployment. This means that there are fewer qualified borrowers to support their banks and you’ll often see credit requirements lowered as banks scramble to secure a customer base. Banks also explore other means of income generation to supplement their profits and keep them ahead of the Fed’s requirements to balance their assets and liabilities.

Many economists point to the surplus federal budgets of Clinton’s administration as causation for the extreme relaxation of credit requirements and the appetite for high-risk investments of banks that led to the ’08 crash and the following recession. In spite of the general aversion to federal spending, especially for safety nets that supplement working-class incomes, the only way out of such a recession that prevents it from becoming a depression as supply chains disappear is massive injections of federal money creation. Had Obama’s cabinet been less weighted toward free-market true believers (neoliberals) the mortgage crisis could have been mitigated for far less and many more people could have stayed in their homes contributing to the recovery.

As it was, many criminals in investment banking were given a pass for their misdeeds and the recovery took far longer than it should have. The general well being of the working class would also now be much better if a few more CEOs and bankers were made to answer for their actions and the federal government upheld its obligation to protect “the people” as its first priority. America’s obsession with meritocracy, in spite of a minimal amount of control the majority of people have in their economy, and its irrational fear of anything that remotely resembles socialism prevented it from fully recovering from the great recession, even to this late date, and will most likely create many future repeats, providing that the impact of a grossly mishandled pandemic response doesn’t strike the final blow to its economy.

It has been said that “None of us is as stupid as all of us” and that is doubly applicable to economics in a democratically elected government.