The Crisis (Pt 6)

U.S. unemployment hits Depression levels

In April, the U.S. Labor Department U-3 measure of unemployment hit 14.7 percent. The U-3 rate had been used over the last year or so to claim that unemployment was the lowest since 1969. In fact, it is designed to greatly underestimate the real level of unemployment. Even some Federal Reserve Board officials admit that the real rate of unemployment is over 20 percent and fast approaching the all-time quasi-official estimate of 24.9 percent that occurred at the very bottom of the Depression in March 1933. Nobody denies that the number of unemployed in the U.S. is in the tens of millions — around 50 million if you believe AFL-CIO President Richard Trumka.

However, it is claimed by Trump and most economists that the current unemployment crisis is the result of the deliberate shutting down (1) of the economy made necessary by the COVID-19 pandemic. What is occurring, according to this logic, is not the long-feared Depression II but the “Great Suppression.” Though unemployment generally declined after March 1933 — except for the sharp but short-lived Roosevelt recession of 1937-38 — “full employment” did not return until the U.S. had entered World War II in 1941. This time, it is claimed by Trump and many economists, in contrast to 1933 there is no underlying economic crisis. Therefore, “full employment” will return much more quickly. The pandemic will have run its course within months, as Trump claims, or at most within several years, as claimed by more cautious economists.

Therefore, the argument goes, while still a terrible situation it is not quite Depression II. Though unemployment may be as bad as during the Depression, it won’t last nearly as long. Anyway, Depression-level unemployment is the necessary price we have to pay to stave off the much greater evil of millions of deaths in the U.S. alone from COVID-19. Not surprisingly, Donald Trump, who had been planning on running on “prosperity and full employment” as shown by the Labor Department’s U-3 unemployment rate, is leading the charge to “open America for business.”

A new industrial cycle begins

The industrial cycle that began with the Great Recession didn’t end classically with a “credit crunch.” However, the global economy was already approaching a recession when the pandemic hit. Then, with the world economy already on the brink of recession, the COVID-19 world-wide pandemic came with its associated government-ordered shutdowns of many businesses and stay-at-home orders. Travel, from expensive cruises to ordinary automobile trips to and from work, declined dramatically causing the demand for and the price of oil to plummet.

What the pandemic did do was bring to a screeching halt the attempts of the congressional Republicans — by moving their massively regressive counter-cyclical tax cut from 2019, as had originally been planned, to 2018 — and the U.S. Federal Reserve System to drag out the industrial cycle that began in 2007 any further.

Trump’s and the Republican’s hopes that the 2007-2020 industrial cycle could be extended to at least November 2020 are now in ruins. However, the Trumpers and GOP are now claiming that there was nothing wrong with the U.S. economy before the pandemic hit. Instead, they are blaming both the pandemic and the economic crisis on China, and even the Chinese Communist Party. If it weren’t for the Chinese “Reds,” Trump and the GOP are claiming, everything would be fine.

It is not only Trump and the Republicans who are blaming China. Joseph Biden’s Democratic presidential campaign also blames the economic crisis with its tens of millions of unemployed in the U.S. alone entirely on COVID-19. Biden holds that while Trump’s reaction to the pandemic was incompetent, the real villain is China.

The ruling class and its spokespeople, Democrats and Republicans alike, are increasingly united on making China the scapegoat. While the Democrats and Republicans were sharply divided on “Russiagate,” they are united on “Chinagate.” Faced by the united ruling-class campaign, many — perhaps most — non-Marxist progressives who lack the compass of a class analysis and Marxist understanding of capitalism are falling head over heels for the blame-China line. They repeat the line of the U.S. ruling class that the “authoritarian Chinese Communist Party” is somehow to blame for the pandemic. Here, we see a toxic combination of both anti-Chinese chauvinism and old-fashioned anti-communism.

The progressives support the argument that “neo-liberal,” “free-trade” policies long before the current crisis allowed China through cheap exports to the U.S. to devastate the U.S. industrial economy. They also support the claim that the Chinese government badly botched its response to COVID-19, which began in China. In reality, the Chinese government’s response to the pandemic has been far superior to the response of federal, state and local governments of the U.S., a fact that the anti-China propaganda attempts to obscure. The economic-nationalist position of Bernie Sanders — still viewed by many progressives as the head of their movement — of opposing the normalization of trade relations with China because it undermines the wages of U.S. workers doesn’t help either.

In reality, the “Great Suppression,” whose effects are certainly very real, is layered on top of a recession that would have become apparent in all probability either later this year or in 2021 even if the pandemic or some other “outside shock” had not occurred. This is not to deny that the pandemic will profoundly shape the new industrial cycle we have now entered. The current economic situation is being shaped by the interaction between the “Great Suppression” the capitalists are increasingly demanding be ended immediately and an underlying cyclical crisis of overproduction.

The U.S. and the world economy came very close to a massive credit meltdown in March (2020) forcing the Federal Reserve to once again embark on a program of quantitative easing. This means the quantity of Federal Reserve-created U.S. dollars, the main means of payment on a world scale, is being radically increased. The many breaks in the chain of payments generated by the economic crisis are being stuffed with what are the electronic equivalent of crisp newly printed dollar bills.

Despite the Fed’s moves, there are growing reports that commercial banks are reducing their loans and credit card borrowing limits. The banks are saying since so many people face massive financial hardship they will be less able to pay off or service their debts. Therefore, the banks are moving to restrict the granting of new credits. All this reduces the demand for commodities independently of the direct effects of the “Great Suppression” and the pandemic. Therefore, contrary to the claims of both Trump and Biden, there is indeed an underlying capitalist economic crisis.

The ‘taxpayers’ money’

Because of its central and growing role in the crisis, I want to concentrate on the Federal Reserve System and its response to the crisis over the next few posts. First, let’s begin with the distinction between the operations of the U.S. Treasury — the financial arm of the federal government proper — and the operations of the Federal Reserve System. The poorly understood relation between these two entities leads to much confusion among the general public about to what extent the trillions that are being given away mostly to the big capitalists in the name of preventing a Depression represent “taxpayers’ money” or to what extent these trillions are coming from somewhere else. To the extent the money is not taxpayers’ money, where are these trillions of dollars the Fed is pumping into the big corporations coming from?

Treasury versus Federal Reserve operations

When the U.S. Treasury spends money, it writes a check against its account in one of 12 Federal Reserve Banks that make up the Federal Reserve System. When the Treasury prepares to spend money, it like a private individual transfers funds from its savings account held in the private for-profit banking system to its checking account. However, the U.S. Treasury’s checking account is held not in a private for-profit bank but a Federal Reserve Bank. The “stimulus checks” with Donald Trump’s (2) name on them that many people in the U.S. are receiving in the mail are drawn against a Federal Reserve Bank.

But how does the government obtain the funds that it deposits either in the private banking system as a savings account or in its Federal Reserve Bank checking account? Essentially, it obtains the money in one of two ways. One way is that it raises money through taxes. The other way is that it borrows the money on the open money market by issuing IOUs. These IOUs are either short-term Treasury notes or long-term Treasury bonds.

If the U.S. government balances its budget — something it has done only once in the last 50 years — it can pay off some of its IOUs as they fall due by writing checks to their owners against its checking accounts in the Federal Reserve Banks. Otherwise, it “rolls over” its debt by issuing new IOUs to pay the old IOUs as they fall due. However, the Treasury must still pay the interest on its debt by writing checks against its Federal Reserve Bank checking accounts. The larger the debt and the higher the rate of interest, the bigger will be the interest servicing costs.

The current national debt is now growing rapidly with the federal deficit that was expected to hit about $1 trillion for the year before the pandemic. It is now expected to be closer to $4 trillion. However, it is much easier to service thanks to the extraordinarily low rate of interest that now prevails in the money market. If this interest rate were to rise toward more normal levels, the costs of servicing the federal debt would rise sharply, which would in turn put further upward pressure on interest rates.

The money raised by the Treasury either through taxes or through borrowing is called “taxpayers’ money” because it is raised through either taxes or the issuing of more debt that ultimately must be serviced through taxes.

Money of account

The Federal Reserve System creates new dollars when it buys an asset — under normal conditions, a short-term Treasury note — with the dollars it creates. The economists claim that the dollars the Fed uses to buy Treasury notes are “created out of thin air.” But that is not true. Where does this money really come from?

Let’s examine the transaction the Federal Reserve System engages in when it buys government or other securities — called open-market operations — a little more closely. We have seen that commodities that have value because they are products of human labor come with “price tags” attached.

Indeed, when the capitalists on their books count the number of commodities, they do so in terms of money and not commodity use values. If they did not use money to measure the value of commodities, they would have no way to measure the number of commodities made up of different use values. (3) In other words, the capitalists and accountants pretend that these commodities are actually money and assign to them a definite quantity of money measured in some unit of currency such as U.S. dollars. We know, even if the accountants and the economists do not, that today’s “fiat currencies” such as the U.S. dollar represent at any given moment a definite quantity of gold as revealed by the dollar price of gold.

Marx called this imaginary money used to measure the quantity of a commodity, not in terms of that commodity’s use value but rather in terms of the price tags that are attached to the commodity, money of account. In this respect, securities like Treasury notes and Treasury bonds also have price tags attached to them, since like commodities they are purchased with a definite sum of money. Again, we see the role of money as money of account, since the securities are valued just like actual commodities in terms of money.

Let’s assume that “A” owns a Treasury note worth a thousand dollars that is sold (4) to the Federal Reserve Bank of New York. “A” will receive an IOU from the New York Federal Reserve Bank to pay him or her on demand in Federal Reserve Notes. However, the money value of the assets held by “A” has not changed. Before, “A” had a government Treasury note worth a thousand dollars, and now “A” has a thousand dollars in his or her bank account. If “A” wants to, he or she can withdraw the thousand dollars in the form of 10 $100 bills. How do things stand with the other party in this transaction, the Federal Reserve Bank of New York?

On its books, the net assets or capital on the books of the New York Federal Reserve Bank has not changed at all. The Bank now has a thousand-dollar U.S. note it didn’t have before but it also has a thousand-dollar “liability” on its books — the previously issued IOU. This is true even though under the present “fiat money” dollar standard it can discharge its debt by simply asking the U.S. Mint to print 10 $100 bills.

This is still rather confusing because the Federal Reserve Bank can discharge its “liability” of a thousand dollars by simply asking the Mint to print 10 new $100 Federal Reserve Notes. And the Federal Reserve Notes are still officially considered liabilities of the Federal Reserve Banks though these banks do not have to pay the owners of these dollar bills (Federal Reserve Notes) anything except replacement Federal Reserve Notes.

Before the New Deal, things were a little less confusing since a $100 Federal Reserve Note was payable in gold coin containing a given weight of money material — gold bullion. (5) This meant that the Federal Reserve Notes issued by the New York Fed were actual promissory notes. If the owner of these promissory notes chose to “cash in” the notes, the Federal Reserve Bank of New York would have to pay off the debt in actual gold coins stored in its vaults.

How the system of fiat money works

Today, we are told by the economists, the Federal Reserve Bank of New York “creates money out of thin air” when it buys securities. This doesn’t sound right and in reality it isn’t right. All things remaining equal, when the Federal Reserve Bank of New York — or any of the other Federal Reserve Banks — buys a security with newly created dollars, the dollar’s value against gold will decline slightly as measured by the price of gold on the open market. Also, the prices of commodities will rise slightly in response to the dollar being worth slightly less gold. This will mean that the money you own, whether Federal Reserve Notes and coins in your pocket or funds in your bank account, though unchanged in terms of dollars will have slightly less purchasing power. This is sometimes called the “inflation tax,” but when the term “taxpayers” is used, its meaning doesn’t include those of us who pay the “inflation tax.”

Of course, things are never really equal. If when the Federal Reserve Bank of New York purchases A’s $1,000 government security with the electronic equivalent of 10 newly created $100 Federal Reserve Notes, those who own gold bullion may not at the existing dollar price of gold wish to purchase more gold at this particular time. For example, new gold bullion produced by the miners and gold refiners might have just hit the market. In this case, the increase in the demand for gold represented by the increased quantity of dollars has been matched by the increased supply of gold, so there is no change in the dollar price of gold.

In that case, the money the Federal Reserve Bank of New York has brought into being out of “thin air” has been created by the workers who have expended their labor while working for the gold mining and refining capitalists and indirectly by the workers who created the means of production and motive power employed by those capitalists. This is where the money that over time the Fed “creates out of thin air” really comes from.

More on what determines the dollar price of gold

Everything being equal, the dollar price of gold will remain unchanged as long as the quantity of dollars created by the Federal Reserve System increases at exactly the rate of that quantity of new gold bullion being created by gold miners and refiners. But things, especially in the short run, are never equal. For example, if a credit crisis occurs and the chief means of payment on the world market are U.S. dollars, a certain number of gold hoarders will be forced to sell gold to raise dollars to meet the demands of their creditors. This move will then be magnified by speculators betting that the market dollar price of gold bullion will fall in the immediate future.

If on the contrary credit strains ease leading to a fall in the demand for U.S. dollars as a means of payment, the reverse will happen leading, again all things remaining equal, to a rise in the dollar price of gold. Therefore, the law that the currency price of gold is governed by the relationship between the growth in the quantity of the currency and the growth of the quantity of gold bullion is true only in the long run, not in the short run.

During a crisis, such as the crisis of 2008 or the one today, the central bank can always create extra currency to meet the increased demand for its notes as a means of payment without the currency depreciating. However, if it is to avoid the depreciation of its currency as expressed by a rising currency price of gold in the long run, it must destroy the extra currency once the extra demand for it has passed.

From credit system to monetary system

The crisis phase in a “typical” industrial cycle marks a transition from a credit system back to a monetary system. As the prices of commodities fall, the quantity of commodities that a piece of money can purchase grows. Therefore, as commodity prices decline the “real money supply” grows. Also, the drop in the general price level relative to the underlying prices of production leads to increased production of money material, meaning that not only the purchasing power of money but its quantity measured in terms of its use value increases.

Also, through bankruptcies enterprises pass from “weak” to “strong” hands. By strong, we mean capitalists who are rich in money capital. In the crisis, when credit dries up it is the person with money who calls the shots. Each crisis, therefore, means an increase in the centralization of capital. Therefore, as the industrial cycle emerges from the crisis proper, many business transactions that will later in the cycle be conducted on a credit basis can for now only be conducted on a cash basis.

The shift from a credit system back to a monetary system occurs to one degree or another in every crisis, whether mild or extreme. But the more violent the crisis is the more thoroughly the job of shifting the economy from a credit basis back to a “sound” cash basis is accomplished.

‘Great Suppression’ versus crisis of overproduction

The current economic crisis has two “souls.” One is the “Great Suppression” as governments ordered “non-essential” enterprises to shut down. The other is a credit contraction that was developing anyway as the 2007-2020 industrial cycle approached its end. As capitalist governments move to prematurely “reopen the economy for business,” industrial production, GDP, and employment figures will likely show considerable improvement.

However, this improvement will face the headwinds of further credit contraction as commercial and industrial capitalists move to liquidate their inventories — commodity capital. If the pandemic and its economic Great Suppression had hit in the late 1940s when the U.S. economy was flooded with cash, the economic consequences would still have been serious. However, the lifting of the shelter-in-place and mandatory closures of nonessential business would have led to a much more rapid recovery than seems likely now. The inflated credit system, in turn, reflects decades of cumulative overproduction.

Since the Great Depression of the 1930s, the Federal Reserve System has been obsessed with preventing a repeat of that debacle, which shook the global capitalist system to its foundations. From the viewpoint of the Federal Reserve leadership, the problem of avoiding Depression with a capital “D” comes down to avoiding a repeat of the massive credit collapse that occurred between 1931 and 1933, within the U.S. and internationally.

Related to this is the belief that the general price level in terms of U.S. dollars must never be allowed to drop. If U.S. dollar prices of commodities do drop, the credit system — built on the assumption that as a general rule the dollar prices of commodities may rise but never drop — will break in a thousand and one places. The Fed fears with good reason that such a drop in prices will trigger a 1931-33 scale or worse credit crisis, which would mean a Depression equal to or in reality far worse than the original Depression of the 1930s.

This doesn’t change the fact that contrary to what is claimed by bourgeois economists, especially those influenced by the ideas of John Maynard Keynes, the failure of dollar — and satellite currency — prices to fall significantly if at all during recessions is not “good” for the working class. Before 1933, even mild recessions brought falls in the general price level. For the working class in those days, the fall in the cost of living caused by recessions somewhat compensated for the reduction in the number of hours worked.

Indeed, the typical pattern in pre-1933 recessions was for real wages — not monetary wages — to rise on an hourly basis during recessions, though the standard of living of the “typical” worker still fell in recessions due either to complete unemployment or reduced hours of work. But after World War II, this was no longer true. At most, the prices of some important individual commodities like food and gasoline might fall. The other argument in favor of inflation is that it is good for the “little guy” because it reduces debts. While it is true that inflation reduces old debts, the rising cost of living forces people of all classes to acquire new debts as commodity prices rise.

The result of the policies of the Federal Reserve — and its satellite central banks in other capitalist countries — has been that since the late 1940s the cyclical shift back to a cash system in recessions has continued but only in a greatly attenuated form. On a secular basis, the system has, therefore, become ever more a credit system working on a relatively smaller and smaller monetary base. The economic system has, therefore, become over the decades an increasingly unstable “house of cards” that the Federal Reserve is now forced to prop up periodically through the massive creation of additional dollars.

Normal Federal Reserve operations and the liquidity trap

Normally, the Federal Reserve manipulates the money markets through the buying and selling of short-term Treasury notes. The Fed’s Open Market Committee sets the desired range for the rate of interest that the commercial banks charge one another for overnight loans. (6) If the rate on the “fed funds” market, as this market is called, rises above the target rate, the Federal Reserve Bank of New York buys Treasury notes adding dollar-denominated reserves to the commercial banking system. If the federal funds rate falls below the target rate, the Federal Reserve Bank of New York sells securities draining monetary reserves out of the commercial banking system. For a more detailed treatment see here.

By these operations, the Federal Reserve System turns short-term government IOUs into the electronic equivalent of — and if the public demands it through the commercial banking system into — crisp new dollar bills. It is considered bad practice for central banks like the Federal Reserve System to buy long-term government bonds in these “open market operations.” The fear is that if the central bank is allowed to buy and sell long-term government bonds this will degenerate into the government simply printing money to meet its pressing needs for cash. In that case, the U.S. Treasury would float more and more bonds with the understanding that the Federal Reserve System would quickly turn those bonds into new dollars by simply purchasing them with newly created dollars.

Such a situation virtually always leads to runaway inflation. It was considered especially important that the Fed avoid buying long-term Treasury securities under the present “fiat money” system because the discipline of even a modified gold standard is missing. Besides, the U.S. dollar is in effect the global currency. (7) If the U.S. dollar ever experiences runaway or hyper-inflation while the dollar system still dominates the international monetary system, the entire global financial system will collapse. Therefore, under “normal” conditions the Fed limits itself to purchasing short-term government securities in its open-market operations.

Monetary normalization

The policy of the Fed “monetizing” only short-term Treasury securities was thrown out the window during the 2008 panic when the Fed “monetized” not only long-term government securities but even mortgage-backed securities. However, the 2008 crisis was viewed by the Fed as a kind of “black swan” event that occurs perhaps once in a hundred years. The Fed promised to return to its normal practice of carrying out monetary policy mainly through its manipulation of the “fed funds” market using only short-term Treasury notes but no Treasury bonds as soon as possible.

Monetary normalization meant that the Fed stopped buying anything other than short-term Treasury notes and the Federal Reserve would gradually begin to sell off its portfolio of long-term government bonds and mortgage-backed securities. Eventually, the Fed hoped, its portfolio would consist entirely of short-term government securities as it did before September 2008.

Today, monetary normalization is in ruins. It began to unravel well before the COVID-19 crisis when a panicky sell-off began in the U.S. stock market in December 2018. The Fed announced that it was suspending its sales of long-term government securities and mortgage-backed securities and began to lower once again its target for the fed funds rate.

The Republican Party and the Trump White House feared that the U.S. economy was heading for an election year recession in 2020 that could not only remove Trump from the White House but have devastating consequences for the Republican Party. The stock market rallied and the threat of an immediate recession beginning in 2019 and extending into 2020 receded. However, the whole process of monetary normalization was set back, since stock market sell-offs and cyclical recessions are hardly once-in-a-century events under the capitalist system.

Then, in March 2020, when it became clear that COVID-19 was a world-wide pandemic threatening millions with death, capitalist governments were forced to issue shelter-in-place orders and order the closure of non-essential businesses. The hope was — though this was never realistic — that this would stamp out the pandemic in a few weeks. But as people were forced to shelter in place and many more people with good reason were afraid to go to the stores except to buy absolute necessities, the demand for most commodities plummeted. In the U.S., unemployment soared right past the post-Depression high point set at the end of the downturn associated with the Volcker shock in 1982.

The collapse in the sales of most commodities set in motion a credit contraction and is threatening a credit collapse that would make 1931-33 look tame. The Fed soon announced that it would put no dollar limits on the number of securities it was willing to “monetize.” These securities included not only long-term government bonds but corporate bonds including bonds of “junk” status.

When does the Fed ‘run out of ammunition’?

Much of present-day bourgeois macro-economic economic theory that attempts to give guidance to what policies the central banks should follow is rooted in the work of John Maynard Keynes. Keynes like Marx realized that no capitalist would undertake a major expansion of an industrial enterprise, let alone create a new industrial enterprise, if the expected return was less than the rate of interest on long-term government bonds. The economists reason that the central bank can put downward pressure on long-term interest rates by gradually lowering its target for the federal funds rate.

As long-term interest rates fall, the reasoning goes, industrial projects judged by the industrial capitalists not profitable enough to undertake because the expected return was less than the rate of return on long-term U.S. Treasury securities would now be undertaken. Economists believe that as long as unemployment of both workers and machinery is higher than considered desirable by the capitalist government — and remember the capitalists certainly do not want to see unemployment disappear — the Federal Reserve should lower its target for “fed funds” to put downward pressure on long-term interest rates.

But what happens when the rate of return on long-term government bonds approaches zero and unemployment among workers and machines is still at a higher level than considered desirable by the capitalist government. Since interest rates are essentially “zero bound” once interest rates fall to a certain point, the Federal Reserve — or other central banks — cannot lower them any further. At this point, the economy is in what Keynesian economists call a “liquidity trap.” The Federal Reserve and other central banks can then, according to standard Keynesianism, no longer lower unemployment through its normal open market operations.

Next Week: Liquidity-trap economics


1 It has been forgotten that it was Nobel Prize-winning economist Milton Friedman supported by no less a man than Ben Bernanke, head of the Federal Reserve System on the eve of the Great Recession, who tried to prove that the 1930s Depression was caused by the Federal Reserve Board — a government agency — and not by capitalist overproduction. Though Friedman’s claims about the cause of the Depression lost some of their luster in the wake of the Great Recession, they still have considerable influence among bourgeois macro-economists.

If we follow Friedman, the Depression was caused by the fact that the Federal Reserve System allowed the “money supply” to contract by one-third, which the Fed could have easily avoided even under the institutional arrangements of the time if it had any idea what it was doing. Indeed, according to this logic it could be claimed that the 1930s crisis was far less serious than the current one because unlike today there was no underlying biological-medical crisis. (back)

2 Up to now, the name of the U.S. president has never appeared on checks issued by the U.S. Treasury. Trump, however, insisted on putting his name on the “stimulus” checks — at most $1,200, which hardly covers a month’s rent — being mailed out to taxpayers as part of the so-called Cares Act. Trump is hoping that the small amount of money represented by these checks will help him win a second term. (back)

3 This problem causes no lack of problems for bourgeois economists when they attempt to explain “value.” We know that commodities have a common immanent unit of measure in terms of abstract human labor. However, the capitalists have no way of knowing the value in terms of abstract human labor. As practical people indifferent to theoretical problems, the capitalists value commodities in terms of units of currency.

As Marxists, we know that units of currency represent quantities of gold bullion measured by some unit of weight. Therefore, capitalists do measure the value — whether they know it or not, even under the “fiat money” system — in terms of weights of gold bullion, the unit of measure of the use value of the money commodity. Therefore, when the capitalists add up the value of commodities with different use values, they do use physical units of measure, but not the physical units of just any commodity but only of the money commodity, which measures the value of all other commodities in terms of its own use value. (back)

4 We are simplifying here. The Federal Reserve Bank of New York when it carries out its “open market” operations works through special dealers who buy and sell government securities to the Federal Reserve Bank of New York. However, this changes nothing in essence in the following examples. (back)

5 In the 1920s, Federal Reserve Notes had a sentence printed on them saying they were payable to the bearer on demand in “lawful money,” understood to be gold coins of a definite weight. This meant they were promissory notes payable in lawful money by their issuer. The issuer was one of the 12 Federal Reserve banks that then as now make up the Federal Reserve System. Today’s Federal Reserve Notes say that they are legal tender for all debts public and private, meaning that are no longer promissory notes but rather monetary tokens, or what the economists call “fiat money.” (back)

6 The lay public, many economists, as well as many Marxists believe that the Federal Reserve System or other central banks set the rate of interest. In reality, the Federal Reserve System possesses no such power. The Fed cannot prevent the rate of interest from rising in boom times nor can it stop the rate of interest from falling during recessions. It can at best manipulate interest rates within a fairly narrow range. I will have more to say about this next week. Therefore, I avoid saying that the Federal Reserve Board sets the rate of interest. (back)

7 In the past, the U.S. Treasury issued currency of its own. This continued into the 1960s in the form of United States Notes directly issued by the U.S. Treasury and not the Federal Reserve System. However, as the final stage of the international gold standard, called the Bretton Woods System, approached, it was considered desirable to end once and for all the U.S. Treasury’s ability to issue its own currency to pay government bills. As things now stand, the U.S. Treasury cannot create the money it uses to pay its bills. (back)