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The President Must Heed Lincoln and Ignore Economists

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The President is convening a bipartisan summit on Monday to debate paying for the government's deficit. Many economists want the deficit cut now - in the midst of the greatest financial crisis in world history. They want cuts - not in funding for bank bailouts, but in entitlements costs in healthcare and social security'.

In other words, the middle class must pay for this crisis - a crisis not of their making. This great nation, the United States, does not have enough money, argue economists, to care for its sick and elderly; to fund healthcare and social security - and finance the recovery.

That is a nonsense. The US can finance what it needs. The US can finance its way back to recovery - and by doing so help the rest of the world recover.

When the economy recovers, the deficit will diminish, just as surely as night follows day. It always has, and it always will.

How you ask? With the help of a remarkable, but everyday invention, known as bank money.

Bank Money

We deal with bank money every day. We could not get by without it. Yet it is one of the best kept secrets in economics.

It is that intangible thing that pays wages, settles bills, and allows us to use credit cards for shopping. It's internet banking.

We never see it. Nor do we touch it. It's not like the coins and notes that we handle every day.

It is credit. And it is a most wondrous thing. It creates economic activity. Unlike taxes, it is not the result of economic activity.

Bank money is based on trust. The word credit derives from the Latin 'credo' - I believe, trust. 'I trust you will pay me.'

So when my employer wires a salary to my bank account, I trust she is paying me. She does not hand me gold or silver coins. She does not deliver greenbacks to my door. She pays with bank money.

There are two institutions that create money - and it costs them next to nothing. They are private banks and the Federal Reserve.

This is how. When you apply to a bank for a $300,000 loan, be sure the bank does not have $300,000 stashed away in its vaults as 'savings'. The bank does not need savings to create credit. It just needs you. Your guarantee - that you will hand over collateral - probably your property - if you can't repay the loan. Oh, and sign a form to pay interest on the freely-created loan.

Hey presto! $300,000 is conjured out of thin air, and deposited - as bank money - in your account. If you had not applied for the loan - that money would not have existed.

That's the easy part. The hard part is draining your pockets each month to repay the bank $300,000 - plus interest.

When the Fed or the banks create money for the US government, the process is more or less the same. The Treasury applies for a loan. For collateral the Treasury could offer a bill. The guarantor is the economy of the United States of America.

So if the government wants to raise $300 billion - it puts up collateral in the form of Treasury bills. The private banks, or the Fed, conjure up $300 billion out of thin air.

The Fed rate on that loan is currently 0 - 0.25%. So the government's borrowing cost could be 0%.

If government could always borrow at 0%, then "money" in the words of Abraham Lincoln, "would cease to be master and become servant of humanity. Democracy would rise superior to the money power." (Abraham Lincoln. Senate document No 23: National Economy and the Banking System of the United States. 1865.)

We could then afford what we need - healthcare and social security - and the US could finance economic recovery.

That's because the $300 billion - bank money - would allow us, the people, represented by a democratic government, to do things that are not being done already - by markets, by the private sector or the government. That money creates jobs and incomes - and savings. It could help begin to end this Great Depression 2.0.

But you ask, how does the $300 billion get paid for? From the taxes of future generations? Not necessarily.

The government might issue short-term bonds (3 months) to the banks to raise $300 billion. But it can later raise more funds by issuing a variety of bonds to the public - newly employed and with income.

So it's a cash-flow thing. The government spends the bank money, and then uses the money raised from bonds issued to the public to repay.

In the meantime the government has created more jobs, income and economic activity. This benefits not just the people of the United States, but foreign economies too.

In 30 years time, when the government has to repay the long-term bond, there's enough cash in the Treasury's vaults - from the taxes, income and economic activity generated.

Ha! you say - what about inflation? Relax. Inflation only becomes a problem in conditions of full employment. Right now full employment is as remote a possibility as bipartisanship on the Hill. Economists are scare-mongering again. The much graver threat is deflation.

Some people think that while low interest rates serve the government and the people as a whole, savers get a raw deal. But savers would be much worse off if the government allowed the economy to spiral ever-downwards.

Some savers have recently been lead to believe that they were entitled to Madoff-type rates of return. That era of excessive returns and fraud is ending.

In the 40s and 50s savers did not get such high rates of return. But the economy was stable, they had jobs and homes and increasingly prosperity.

That's because back then, democracy, in the words of Abraham Lincoln, "rose superior to the money power."

We must once again make money work for the people.