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Wednesday, October 29, 2014

Why the US Can Never Go Bankrupt & How Modern Banking Really Works

When talking on the US economy and more specifically the massive debt load burden it holds, some like to mention of an ultimate 'endgame' where  magically creditors call in their loans and 'the gig is up' as it were for the Fed..

It is a nice fantasy to imagine this occurring followed by a lot of formerly super-wealthy people full of desperation collectively jumping off large bridges

But unfortunately that isn't the reality of things.

The following info we try to explain as clearly, concisely and slowly as possible for the every-day layperson to understand..   Don't be intimidated.. Just read slow and try to picture what we're expressing..
Truth be told, and we wish it weren't so, the evil evil Federal Reserve can never run out of money..

For instance when former Fed Chair 'Bastard' Ben Bernanke was in power and did an interview with 60 Minutes as a fluff piece to calm investors fears, Benny was asked, "Is that tax money that the Fed is spending"?

To which Bastard Ben replied, "It's not tax money..  We simply use the computer to mark up the size of the account"

In other words, a couple presses of the keyboard.. a '1' here, a few 'zeroes' there and Ta-Da..
As long as someone at the Fed has a finger and they have a key to stroke, they can't possibly run out of money..

Second, there is this statement from the St. Louis Fed:

“As the sole manufacturer of dollars, whose debt is denominated in dollars, the U.S. government can never become insolvent, i.e., unable to pay its bills. In this sense, the government is not dependent on credit markets to remain operational.”

And as long as the US remains the reserve currency the rest of the world depends on, this unfortunate statement on the government is Fact.
Government can never run out of dollars. It can never be forced to default. It can never be forced to miss a payment. It is never subject to whims of “bond vigilantes.”

Thus, there is no need to balance the budget - it is mere myth or rather a political parlor game used to rile or scare the poop out of the public every election cycle..

None of what we're talking about will make true sense unless you understand how modern money works

So its probably best to start with the banking system.
OK, so a firm approaches a bank and says it would like a loan,..

Where does the bank get the money?”

It creates it out of thin air, out of nothing.

The 'money' used to provide the loan is keystroked it into existence.

It creates a loan (an asset for the bank) to the firm and offsets it with a deposit (a liability for the bank).
So now, the firm gets a credit (an asset) and an offsetting debit (the loan), and no prior deposits are needed.

Loans create deposits and the bank lends its own IOUs.

Now can they ever run out of their own IOUs?

Of course not.

This is important. If you don’t get this, banking will forever remain a mystery

The firm then takes the loan and uses the proceeds to hire people from community households. People i.e. employees then use the funds (salary) to buy the product from the firm, and the firm uses the money to repay on the loan.

It’s a super-simple model when one understands it...

So let’s add another bank and a central bank to make it more realistic.
Let's say the firm and employee X use different banks...

The banks have to clear with one another. They do this through the central bank by using the IOUs of the central bank — called reserves.

So what happens if Bank 1 is short reserves to clear the account?

The central bank creates reserves so that Bank 1 can clear with Bank 2.
And can the central bank run out of reserves?


Deposits create reserves. So the central bank will accommodate the demand for reserves by creating them in loans.

Banks repay those loans to the central bank by returning the reserves back to them.

Now, how about the government?
The U.S. government spends its currency into existence.

Huh?  What exactly does that mean?

The government spends first and then collects taxes and taxes are what give the dollar value.

As explained once by a credit theorist named Alfred Mitchell-Innes: “A dollar of money is a dollar, not because of the material of which it is made, but because of the dollar of tax which is imposed to redeem it.”
When someone says the country is bankrupt, that simply isn’t true.

The Treasury spends dollars into existence through the central bank which is the Fed.

They in turn credit the accounts of banks, and banks credit whoever is getting paid.

Taxes reverse the process. Banks then debit accounts, and the central bank debits the banks.

So you see, the government cannot run out of credits.
Money, then, is simply the way we keep score in a modern economy.

Banks are the scorekeepers.

Now you have some understanding of modern money.

And so when someone says the country is bankrupt or that it relies on the Chinese or Japanese to finance it, you’ll know that simply isn’t true.

It is just part of kabuki theater by people in positions of finance and/or political power with agendas based on populace fear.