Before QE, there were two ways money entered the U.S. economy. When it was legal to require payment in gold or silver (outlawed in 1933), it was possible to increase the amount of money in the economy by mining gold or silver or using gold or silver on hand for payment. The one consistent way money has always entered the economy, however, is through debt.
Private debt, whether for production or consumption, is used for purchases. Every purchase is income for the seller. Just like that, the borrowed money has entered the economy. From there it can circulate indefinitely as additional purchases are made with it.
There was a time in this country when individual banks created their own debt; they would simply print promissory notes. They promised to redeem those notes for cash, or even gold, to whoever presented it to the bank.
Banks would use those notes to fund loans, which were undertaken for the purpose of making purchases. Rather than take the notes to the bank for redemption, sellers could use those notes to make other purchases, whence they would be used for other purchases, etc. They became money.
In normal circumstances (i.e., absent a monetary panic), those notes were most likely to be redeemed when they landed in some other bank.
The printing of notes by individual banks has since been made explicitly illegal. [Today a faint echo of that practice remains with our money: if you read a piece of paper money carefully, it is officially a “Federal Reserve Note,” but the only thing it can be redeemed for is another Federal Reserve Note of the same denomination. A very excellent, very, very brief history of money in this country is here.]
When banks lend money, they generally lend more money than they actually have on hand, but they are not really creating new money. That is a common perception that is even fostered by most economists. What they are really doing is increasing the ‘money multiplier,’ the number of times the actual supply of money turns over in the economy over some period of time (usually measured by the year).
Either way, when banks make loans, money is getting into the economy, where it will then circulate indefinitely. [The size of our economy for 2014 was roughly $17.4 trillion. As of December of last year, the actual supply of money, counting only the paper money and coins in circulation, was about $2.9 trillion. Dividing the first of those numbers by the second number yields a money multiplier of exactly 5.1.]
Unambiguous additions to the supply of money have occurred when money to be used by the federal government for its myriad purposes has been printed by the Treasury Department. Since the Federal Reserve System (the Fed) was established — and before QE — that has happened when the federal government has had to borrow money (by selling bonds). The Fed has usually decided to have the Treasury print some amount of money to hand over to the Fed for it to lend to the government (by buying some of those bonds). [‘Lender of last resort’ means the Fed guarantees that all bonds offered for sell by the federal government will be bought, one way or another.]
Here’s the thing. It turns out that debt is not a good way to get money into the economy. For one thing, it is inefficient. Debt grows faster than the economy does, meaning, in economic terms, there is a diminishing return in economic growth from additional increases in debt (e. g., here — see the short explanatory note below the graph).
Even worse, debt actually causes economic instability — the boom-and-bust cycle that has plagued this economic system from its beginning to the present.
In The Next Economic Disaster, published in summer 2014, Richard Vague makes the case that debt is the cause of economic instability. Looking at the entire history of our economic system, and even other times and places, he found that increasing debt was the only factor that was always present in the booms that have precipitated economic busts. It is because the booms — periods of prosperity — have depended on debt that busts have inevitably ensued.When banks make loans, money is getting into the economy, where it will then circulate indefinitely.
Forgive me for stating the obvious, but this tells us that to eliminate economic instability we need to have some means other than debt of getting money into the economy. Quantitative easing pointed toward a way of accomplishing exactly that.
The Fed had the Treasury Department print money for it to give to banks and other “major financial institutions.” Those financial enterprises handed the Fed ‘assets’ in exchange for that money, but these assets included the infamous ‘toxic assets’ that literally have no actual worth as well as other assets of questionable market value. [Some might argue that the Fed was technically lending that money to those enterprises, but a “loan” with an interest rate of zero and no schedule of repayment whatsoever is in reality a gift.]
The money that the Fed had the Treasury print for it to give to the banks was intended to encourage lending, but there was no such caveat attached. That money could be used for any legal purpose, such as buying stocks. When banks did buy stocks or other assets with that money, it increased their capacity for lending, which the Fed wanted.
The critical point here, however, is that when such purchases were made, that money entered the economy without debt. Due to the way this was accomplished, the most immediate and biggest benefits from the money the Fed doled out went to the ‘investor class,’ but again, the money entered the economy without debt being incurred.
What if money was made directly available to individuals, without incurring debt for it, who would get it into the economy when they used it to make purchases? That would provide the business sector with an absolutely guaranteed stream of revenue from those consumers. All of that money would be the supply of money for the economy, getting the entire money supply into the economy without debt.
A monetary system using that very idea has been designed (here or, in more detail, here). It has been in development for the past several years (since summer 2010, to be exact). It is not radical. Implementing it would not change the nature of our economy.
This monetary system would, however, be revolutionary. It would change the way the economy functions. Recessions (or worse) would be literally an impossibility. The boom-and-bust cycle that has always plagued this economy would be of historical interest only. There would be no need/excuse (depending on one’s ideology) for ‘managing’ the economy using monetary or fiscal policy. (In reality, there would be no means for indulging in monetary or fiscal policy.)
Even better, it turns out that using this system to get money into the economy makes it possible to accomplish other good things. For instance, we could eliminate (involuntary) unemployment and poverty at no cost to anyone and without redistributing anything. We could even eliminate using taxes to fund government.
Government — all government — could be funded (as fully as at present) without using taxes and without debt, as part of the operations of the monetary system, and with no excuse/need (depending on one’s ideology) for any welfare of any kind.
Now, that’s my kind of revolution!