In the latest episode of InFi, I showcased several quotations and two video clips from economic analysts, all having to do with money and debt. In the present post I’ll highlight just one quote (from Perry Mehrling) and one video clip (from Jeff Snider) to illustrate the relevance of the Federal Reserve to the USD-based financial system. This might seem like an odd thing to say—as if I stressed the importance of clouds to the water-based ecological system—but as we’ll see, many sophisticated analysts try to brush away the importance of the Fed altogether.

 

The present post simply reinforces the central point I was making in my recent three-part blog post series (one, two, and three), which is that the central bank has far more power than the commercial banks, even though it’s true that they in turn have more power than other businesses. Both the commercial banks and the Fed can “create dollars,” but there’s a qualitatively stronger sense in which the Fed can do so.

 

Perry Mehrling on Circularity

Here is the screenshot of a tweet featuring the quote from Mehrling:

For those readers who have already slogged through my 3-part blog series, it is easy enough to see what’s right—but also wrong—with Mehrling’s quote.

 

First let’s start with how he’s right. Suppose you have a checking account with Bank of America that has $1,000 “in” it. You proudly tell people, “I have $1,000 in the bank.” And indeed, if you go to the store and buy (say) $400 of merchandise, in a typical scenario you can swipe your card, and then Bank of America will transfer $400 of its debt to you, over to the merchant. So if we ask, what does it really mean to say you have $1,000 (in this context), what it really means is that Bank of America owes you $1,000. And in normal times, the way our society works, if a reputable bank owes you $1,000 upon demand, that’s just about the same thing as saying you “have $1,000.”

 

With that train of thought in mind, I invite the reader to look again at Mehrling’s quotation above. This is clearly the kind of thing he has in mind. In our example, what the $1,000 “is” is simply Bank of America’s promise to pay to someone $1,000 upon request.

 

But if you think more about it, that’s a bit weird. How can US dollars themselves be merely promises to pay US dollars? It would be as if someone said, “I promise to make a promise to you in the future.” And then if you ask, “What kind of promise?” the person replies, “Like the one I just enunciated.” If you think too hard about that, your head explodes.

 

Fortunately, we can safely step out of Mehrling’s self-referential paradox. As everyone knows, there is something much more specific that commercial banks have in mind when they say, “We owe you $1,000 upon demand.” Namely, they promise that they will hand over Federal Reserve Notes totaling $1,000 in face value. 

 

If what Mehrling said were true, then a bank run would be impossible. Nobody could go to a bank and say, “Hey! It says here, you owe me $1,000. I want it.” Because, if we are saying what the money actually IS is merely the bank owing you $1,000, the teller would say, “Your wish is granted.” Like Dorothy in the Wizard of Oz, you would realize you held $1,000 all along. The fact of Bank of America owing it to you, was the same thing as them already having paid it—if Mehrling were correct.

 

But to repeat, he’s not correct. We all know what it means to say the bank owes you money. It means they can produce Federal Reserve Notes—or, if we want to get technical, they also could electronically transfer some of their reserve balances the bank itself holds with the Federal Reserve—over to the creditor. This is neither circular nor self-referential.

 

Jeff Snider’s Claims about Ledger-Based Money

There is a similar dynamic at work in a video Jeff Snider—creator of “Eurodollar University”—put out, with the provocative title, “Everything You’ve Been Told About the Dollar Is Wrong.”


For our purposes in this post, we just need to consider the first 2 minutes of Snider’s video (which otherwise is packed with much useful history and commentary). Snider says:

 
The dollar we all use is a ledger dollar. Not government money, and sure as hell not Federal Reserve money. It’s a form of bank money, because banks are the bookkeepers. They are who society has chosen to keep track of all of its commercial and financial transactions….Our modern society utterly requires the kind of mobility and flexibility, only a ledger money can provide. If you actually think about this and go through history, the dollar that everyone thinks of, never really had its day. The bank dollar did, and then certainly the Eurodollar, but fiat money was never really a thing because the free market had vastly different priorities. Now physical dollars still exist and can obviously be exchanged, and even banks will accept them, it’s just that the vast majority of the world wants nothing to do with that form of money.

 

As with Mehrling, here too with Snider’s historical account, we can understand where he’s coming from. But strictly speaking, his claims don’t make sense. During the financial crisis of 2008, it was the Federal Reserve that went around, bailing out some financial institutions while letting others die. Even household name banks can go down overnight if there’s a panic, because—with the practice of “fractional reserve banking”—their business model is inherently illiquid; they borrow short and lend long.

 

In contrast, ever since Nixon killed the last vestiges of the gold standard in 1971, there can’t be a “run” on the Federal Reserve. If you have $1,000 in Federal Reserve Notes, they don’t “owe” you anything, except Federal Reserve Notes. The Fed keeps its old accounting framework, carrying FRNs on its books as outstanding liabilities, but it doesn’t mean what it did under the gold standard.

 

In point of fact, since the Fed began aggressively hiking interest rates in 2022, the Fed is literally insolvent in a mark-to-market accounting sense. But unlike Silicon Valley Bank, the Fed keeps chugging along. That contrast perfectly illustrates the qualitative difference between the Federal Reserve and mere commercial banks, as “issuers of US dollars.”

 

 

Dr. Robert P. Murphy is the Chief Economist at infineo, bridging together Whole Life insurance policies and digital blockchain-based issuance.

 

Twitter: @infineogroup, @BobMurphyEcon

 

Linkedin: infineo group, Robert Murphy

 

Youtube: infineo group

 

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