Joe Sixpack can be forgiven his ignorance of creating money because he doesn’t. He believes money comes from his employer as a paycheck or from a bank which loans him money taken out of its vault. Joe knows that when he loans his brother-in-law $100 it comes out of his own pocket. Commercial banks regulated by the Fed create the money they loan Joe Sixpack out of thin air. That loan is brand new money, printed if you will, by the bank under strict oversight, we hope, of the Fed.

The bank demands interest be paid on this new money, debt-money it is called, to distinguish it from legal tender, cash, printed by the US Treasury which earns no interest. More confusing to Joe, the bank calls his loan an asset while Joe calls his loan a liability. Words, words, words!

So what is the "backing" of this new interest-earning bank-created money? It is the faith the bank has in Joe that he will pay interest on it and repay the loan on schedule. A Federal Reserve Note, "This note is legal tender for all debts public and private," printed and spent by the US government, is backed only by the "Faith and Credit" of the US government. As has always been the situation, money is anything accepted as such and is only worth what it can buy. Why then is bank created money, credit, vital to the functioning of the Economy while Treasury printed money is decried as inflationary?

US Treasury Secretary Rubin got the Glass-Steagall Bank Act of 1933 repealed in 1999, his last "success" before leaving for Citigroup, or as his Wall Street friends joked, his first act as Citigroup executive. Until then commercial banks with a limited right to print money could not legally own corporations which borrowed it but were doing so clandestinely anyway. Wall Street considered this an old fashioned view of finance, a legacy of the crash of 1929, needlessly limiting the activity of today’s well managed banks. Now we see Bear-Stearns an "investment" bank which can’t print money bought by J.P Morgan Chase which can print money. To broker the deal, the Fed granted J.P. Morgan Chase a 28-day "loan" of $29 billion of legal tender, cash, fresh from the US Treasury!

‘Well managed’ banks were happy to create money for secretive hedge funds, high-risk mortgages, corporate take-over schemes, and to finance credit cards which allow consumers to effectively print their own money. To disperse the risk of all this kind of money-creation, loans were repackaged and resold to buyers far removed from the original loans. In old fashioned banking the bank and the loanee stayed together and shared the risk jointly. Banks monitored these loan assets on their books of accounts and were quick to handle any challenges which might arise.

This latest and perhaps terminal world financial crisis arises from defaulting original loanees who are untraceable. There are no "holders in due course" accountable for defaulting loans. No private party wants to gamble on buying tranches of sliced and diced debt. What are they really worth? Let the market decide? The original selling price? It’s anybody’s guess!

The Bank of Last Resort is again the Fed in the US and the central banks of other countries which print legal tender. How much like the Great Depression era game of Monopoly where the banker would hand out new money to keep the game going! Desperate to keep the world economy going, central banks are now effectively buying these tranches with legal tender only they can print to restore deficient bank reserves.

What seems lost in the noise is the fact that all this "funny money" has built great amounts of new private homes. The owners may default but a real material asset remains no matter the bookkeeping. The US Treasury, to finance production of war material to win WW II, printed money to pay the women factory workers while men were mostly unemployed in productive labor fighting on front lines destroying real property. To sop up the great amounts of new money entering circulation with no civilian products to buy, War Bonds at $18.75 were sold. In 4 years WWII was over and to protect a reviving peacetime market economy vast amounts of left-over war material with peaceful utility was destroyed!

There is strong evidence that the remarkable Chinese economy with a steady incredible growth in housing, highways, and consumer products selling to an affluent middle class, is a result of the Chinese government printing money for peaceful purposes as did the US in WWII for warfare. The Chinese government does not seem to carry a national debt and sells Chinese Treasury bonds to cool its economy not to finance it! With so much mind boggling infrastructure construction pouring yuan into circulation, some cooling seems necessary.

This May China increased the commercial bank reserve requirement again to now 16% reducing the quantity of loans they can make to a maximum of 6x their reserves. This is an alternative way to reduce bank money creation rarely used in the USA in preference to the "one blunt tool" of increasing interest rates which bankers like!

Could this be the money model, a Chinese model, for a world economy to replace the dysfunctional financial system now in crisis?

– from Economic Reform, July 2008