The phrase “money printing” conjures images of a giant printing press spitting out sheets of hundred dollar bills somewhere in the basement of the Fed.
But is that what’s actually happening lately? Absolutely not.
Join John Flaherty and Monetary Metals CEO Keith Weiner for a conversation that will likely make you say “WOW!” or “Whaaat?” or maybe even “Oh, NOW I get it…”
John: Hello again and welcome to the Gold Exchange podcast. I’m John Flaherty. I’m here with Keith Weiner, founder and CEO of Monetary Metals. We often hear the phrase “money printing,” and it conjures images of a giant printing press spitting out sheets of hundred dollar bills somewhere in the basement of the Fed.
But is that what is actually happening? Keith wrote an article entitled What is Money Printing several years back, and it lays out a series of examples that build on each other to make the case that the Fed is not actually printing money, but in fact, doing something else a little more nuanced. What is that something else you ask? Listen on. Hopefully this episode will provide an epiphany or two.
When I hear the word epiphany, I can’t help but think of The Simpsons movie where Homer is in this yurt, somewhere in Alaska having an ayahuasca trip. And the epiphanies that he starts to have are that bananas are a great source of potassium, and my favorite, that Americans will never embrace soccer. Sorry for that tangent, but that’s what comes to mind when I hear the word epiphany. Anyway, let’s get into this article.
Keith, you first start by talking about Henry the Homeowner, where Henry goes and finds the perfect house, borrows some money and gets a mortgage. And you ask the question, is he printing money? Why don’t you tell us what concept you’re trying to introduce here, this first example.
Keith: So I guess the backdrop to this is I’m trying to introduce the concept of the balance sheet. We have an asset and then think, OK, you got rich. So suppose and homeowner forget what he’s borrowing from. Then he suddenly comes into possession of a new house that’s worth, I think, and maybe in that article I said a hundred thousand dollars. But in light of how crazy the real estate market has gone recently, maybe it’s the million dollar house.
He comes into a million dollar asset. And does that mean he’s a million dollars richer? No, of course not. It means if you look at the other side of his balance sheet…the house is the asset. If you look at the other side of the balance sheet there’s a liability of…Let’s say this is the world of zero down payments, it’s a million dollar liability to match his million dollar asset. And so all that’s done is he’s borrowed a million to buy a million dollar asset. He’s not actually richer. The appearance of riches or the illusion of riches, which is this is an aside will come as the Fed continues to drive interest rates lower and asset prices go up. And they call this the wealth effect. I’ve said many times the wealth effect is not wealth, in the way that pasteurized, homogenized, air-blown cheese whip from a can is not cheese. So he has a million dollar liability, a million dollar asset, he has borrowed to buy an asset. And he’s not richer.
John: Gotcha. All right. The next the next individual here is Barry the Bond Holder. No real difference here. Same example. He borrows money to buy a bond. Barry is only different from Henry in that he bought a bond instead of a house. So any anything to add there?
Keith: Well, what I wanted to show is that whether you buy a tangible asset or whether you buy a financial asset, the concept of borrowing to buy an asset, again, looking at the balance sheet: million dollar liability to finance the purchase of a million dollar asset…you haven’t created any new wealth. Now, obviously, if you buy a bond, the bond is an income producing or yielding asset. And so then as the interest payments come in, and of course, you have to pay interest on the money you borrowed, if you borrow it at a lower interest rate, let’s say you borrow at 0.25%, you’re lucky enough to be able to borrow at short term LIBOR, and you’re doing duration mismatch and this is a nice long term mortgage. Maybe you’re making 2.25% on…and that wouldn’t be government securities at that point…that would be some sort of corporate. You’re earning 2.25%, you’re paying 0.25% and you’re earning a net spread of 2.0%. You’re creating wealth in there, but not on the balance sheet and the asset versus liability.
John: Gotcha. So now let’s shift to Frank the flipper. Frank takes out short term hard money loans say buys the house across the street. That’s shabby, paints the walls, fixes the roof and then sells, sells the house and and repays the note. So you say Frank differs from Henry in that he has to sell the asset to repay his short term funding. But…any money printing in this example?
Keith: So what I’m doing in this article, and this is worth underscoring, is making a series of incremental examples, each one to introduce an idea, or an idea in a different light. Frank the Flipper is now obviously in the business of turning assets over and borrows. Buys the asset. Does something, turns it sells it. As you noted, he repays the loan not by amortization. By earning income that pays it, and even in the case of of the bondholder, he’s able to pay the loan because he’s earning interest on the bond he bought. In this case, he’s able to repay the loan by liquidation of the asset.
He’s selling assets into the market and that essentially someone else is taking over financing it. So it moves elsewhere in the banking system aggregate balance sheet. And he’s out of the loop.
John: All right. So now we ratchet up Frank’s example with his brother, Magnus. You point out that Magnus is able to set up kind of an instant self-underwriting mechanism whereby the moment he finds a house, he can press a button, borrow the money, asset is improved and sold and returned. But that starts to happen in succession one after another. So the point you make is Magnus is different from from Frank because his good credit persuades the bank to give him discretion to initiate his own loans. Any any money printing here?
Keith: Right. So, obviously I’m ratcheting up. I’m now saying that he is getting a loan, but on his own recognizance. He doesn’t go paperwork-in-hand to the bank and say, would you give me a loan? And the bank makes them wait six weeks. So in this case, it doesn’t have to go to the bank, per se, his internal controls are so good, his valuation methodology he’s using, the bank wants them to find to be comps. His documentation is impeccably prepared. He has auditors and other means of internal and external controls, and the bank has become comfortable enough with him that they’ve given him some sort of limit, obviously. But within those limits, he can literally self-initiate loans. And then, of course, the bank will review, and they find that he bent the rules or cheated a little bit, then they’ll take away his privileges. And so I’ve introduced the variable in this one that he is self-issuing.
He is printing, if I can use that term, his own mortgages. But is that money printing? No, it’s not.
John: No, there’s an offsetting component to it. So the next example is Bob the Banker, which is Barry the Bondholder’s cousin. And this is basically just the same ratchet. Right? As Magnus to Frank, in that Bob the Banker has the ability to push a button and buy as many bonds as he wants. Anything to add with this?
Keith: Well, obviously, we’re getting closer and closer to the Fed’s model. But again, you’ve got a got a commercial bank, presumably with internal controls that are really strong. It’s audited, it has all kinds of things in place to make sure that it wouldn’t borrow money in order to slip it out the back door to Bob and his family. You know, the money is always going into buying the bonds – that’s their business model, to buy bonds. Some people would say the banks print money, they might balk. They might say on all the previous examples, no money printing, but this is a bank and therefore it’s printing. To which I would say…I saw a quip, somebody on social media recently said there are two kinds of economists in the world, those who understand the balance sheet and those who don’t. And again, this is a bank. It’s a balance sheet business. It adds a million dollars in liability in order to finance the addition of a million dollars an asset.
And as long as that’s what it’s doing, then there’s no free money being created there.
John: So I think this is a big question out there, maybe we dedicate a separate episode to it, but is this related to fractional reserve lending and the notion that when you borrow for a mortgage, say, that the banks just conjure that up. And that money, quote unquote, is borrowed into existence out of thin air?
Keith: I think there are some other confusions related to fractional reserve banking. It may be better to leave that to another episode. I will say that in what is now called fractional reserve banking today, there are multiple things compounded on top of each other. And that’s usually the case with contentious political issues. One side is looking at one aspect of it. Another side is looking at another aspect of it, or both of those aspects are bundled into a single word so that when that word is said, the two respective factions, if I can say that without depending upon on fractional reserve banking or any other issue, you hear that word and then immediately in their mind, picture their aspect of the problem.
And one of the problems we have today is duration mismatch. Is the borrowing short or particularly borrowing with zero duration in overnight money or demand deposits from bank depositors and then buying long term assets like 10 year Treasury bonds or 30 year mortgages. And that duration mismatch is absolutely a destructive phenomenon. I’ve written about that many times.
John: Let’s agree to defer the deeper dive on fractional reserve lending to a future episode.
So, moving on to the next example. We ended with Bob the Banker and Bob’s son, Morgan. I wonder why you picked that name? He expands the family bond business by borrowing from retail savers and corporations. Now, what is the principle here?
Keith: You’re not going to say there’s also two kinds of economists in the world, those who have really dry and boring names in their anecdotes, and then there’s others that use names like Maynard on one hand and Morgan.
So Morgan is obviously in the business of banking. The change in this example is that he’s not going to some banking or corporate lender per se to fight. So he wants to borrow a million dollars. It doesn’t have to go to some bank and borrow the million dollars. He now is literally a bank and is borrowing the million dollars from the public. He opens his doors he gets a banking license, he’s able to print on his glass, FDIC or whatever it is, and member, of whatever banking association.
The public is encouraged to walk in, open accounts. All of whom, of course, have the misconception that they have money in the bank and don’t quite understand that what they have is a credit to the bank. They have a piece of paper from the bank that the bank says, we promise to repay your cash under the terms of this agreement. Which may be on demand or may not be. They have a misconception in thinking that means they have money in the bank.
Morgan isn’t really doing anything all that different from from his dad. It’s just that he’s doing it in a more systematized way and has organized a bank as a vehicle in which to do it.
John: 10-4. All right, so final example on the on the ladder here. You say let’s look at Bill Trader. Another good one, Bill Trader. His firm buys and sells Morgan Banker’s debt. So he is a market maker and his trading provides liquidity to the Banker’s debt paper.
And then you go on…h’s so successful that the wholesalers begin to accept in payment of their invoice, accept it, meaning the the debt paper. They accept that for their invoices because it suits them better than the alternatives. And then you ask the question again, does Bill turn Morgan into a money printer?
So how is this the last step on the rung here, Keith?
Keith: So I’m trying to remember what I wrote, but what I want to make clear is that what becoming liquid and what wholesalers are accepting is Bill Traders paper, not necessarily Morgan’s paper, though that can happen there, too, potentially. That Bill Trader’s paper becomes liquid enough within certain parts of the economy, that people are accepting it as a currency. That is, for the settlement and clearing of credits between themselves.
Some party A, let’s say, buys something from party B and then has to pay net 90, and then they can pay that off by, instead of handing over the money itself, they’re handing over Bill Trader’s paper and that’s being used to clear it. So this example obviously increments, as we’re getting closer and closer to what the Fed does, that Bill Trader’s paper is more liquid than Morgan’s paper, even though Bill Trader is financing Morgan.
He issues his paper to buy Morgan’s paper. And his paper is more liquid, by virtue of what he’s doing with duration mismatch in particular, but also in how he set up a structure and a bunch of other things that are out of scope. And so his paper becomes more liquid. It’s being used as a medium of exchange. Most people have a confusion. And because, in a lot of cases, if you look up the definition of money, they would say medium of exchange.
And so arguing from definitions, which is always a dangerous thing to do, by the way. One should never try to deduce from definitions and dictate to reality “what the truth needs to be, because this logically follows from my definition.” I would argue, well, if your definition logically leads to a contradiction with reality, it’s your definition that should be checked, not reality. But because money and medium of exchange, are so commonly conflated, people say, well, geez, for sure, Bill Trader is printing money because, look, his paper is being used as a medium of exchange.
And the answer to that is, yes, currency can be used as medium exchange and currency is not necessarily money, as is the case today. I’ll give away the punch line: the proper definition of money is not whatever happens to circulate as the medium of exchange, which changes as you cross the border to border to border and go to different countries. The definition of money is the marketable commodity. So, that being gold.
Currency, the definition that I would give, is the most marketable credit. So because of how Bill Trader has run his business, his credit is more liquid and more marketable than Morgan’s. And so it’s been used as currency, not as money. And that adds one more element to the confusion of the succession of examples, is Bill Trader printing money? Well, he has the same thing in common that all the rest of them do, in that he is issuing a credit to finance the purchase of an asset. That is, he borrows a million dollars worth of whatever, to finance the purchase of an asset that’s worth a million dollars, whatever, except in this example, the confusion is people begin to think of his credit issuance as the million dollars.
So they’ve confused the credit paper that says, I owe you a million dollars. That’s what Bill Trader issues. They’ve confused that for the million dollars itself and say, look, Bill Trader has created a million dollars. No, he hasn’t. He has just simply said, I owe you a million dollars. In other words, you’re his creditor. You’ve lent him the million, enabling him to buy the million dollars worth of Morgan’s debt paper.
John: All right. Did you get all that, ladies and gentlemen? That that one that one takes a bit of noodling. But this is in print, and we encourage you to go and and read it as many times as it takes.
OK, Keith, let’s get to the let’s get to the bottom line here. Now we arrive at the Central Bank. Please help us connect the dots with all of these examples built up here.
What does Central Bank, and how they issue their credit, what does that have in common with these examples? And then what is the major difference that sets them apart from these otherwise free market examples that you detailed?
Keith: Well, the central bank is a balance sheet entity that is issuing liabilities to finance the purchase of its assets. Its assets are generally financial assets. It doesn’t buy the house. It buys the debt paper that finances the house. The Fed is purchasing mortgages. It’s also purchasing bank debt and corporate debt and all kinds of things. And, of course, government debt.
It is emitting highly liquid, highly marketable paper, which we call dollar bills and also electronic dollar credits. And it is doing so of its own recognizance. It is of such high integrity, and such strong internal controls, and such unquestioned honesty, that it is entrusted – and I say that tongue firmly planted in cheek in case anybody gets the wrong idea, because the whole system has gone horribly wrong. But it is entrusted with the power to issue its credit paper, these dollars, which are highly marketable. They trade at zero spread.
Marketability is a measure of the loss that one takes to get in and out of it. And that’s the bid-ask spread. The bid-ask spread on dollars is…there is no spread. So, extremely efficient. And the Fed, in addition to that, its assets are turning over rapidly. And as one asset, as the Bill Trader did, it’s buying, and in theory supposed to be selling. It doesn’t sell very often. But as one government bond matures, it’s buying another.
So it has a lot of turnover at the edge of its balance sheet. It issues credit that everybody considers to be money because they’re operating on the definition of money as a currency. A medium of exchange. That’s the similarities with all the other examples.
The difference, of course, is that, well, two things. One, although I think most people could probably see that Bill Trader is not the government, it’s not official. That it may be what Bill Trader is issuing isn’t money, because the Fed has legal tender laws backing it. But what the Fed emits, is indeed money. And then they totally lose sight of the fact that the Fed is doing that to finance the purchase of an asset that is a liability, to finance an asset. And people also think, well, the Fed is never going to repay you, which is true. Therefore, the liability side doesn’t matter. There is no such thing as a liability. And the Fed is just simply creating money out of thin air. But really, the only difference is that the Fed has been given the legal privilege of being the exclusive emitter of currency.
Anything else that someone else were to create that is in a currency, is either highly forbidden, or in the case of banks, they have certain limited license to do that. Kind of a sub-license under the Fed. So the Fed has been given a legal privilege that nobody should ever be given. And once somebody has been given a legal privilege, going back to my tongue in cheek comments about integrity and trust and so forth, once somebody has been given a legal privilege to be the monopoly issuer of something, then it’s just a matter of time.
All the principles and all the systems internal to that entity will go bad because that kind of power invites abuse. And sooner or later it will be. We’re in relatively late stages of that abuse right now.
John: So the Fed is not actually printing, but borrowing. Do I have that right?
Keith: The Fed is borrowing period. I will defend that hill to the death. It is not incidental and that is not a rhetorical tactic to, you know, some sort of argument by hyperbole in order to make some other point.
That is what it is. It is borrowing.
John: OK, so we often hear the Fed referred to as the lender of last resort. Would it be more accurate to say they are the ultimate borrower rather than the ultimate lender?
Keith: Well, they’re borrowing in order to lend. So it’s kind of like, if I sit here and I say “I have this magnet that has a magnetic North Pole.” Well, as we know from physics, there’s no such thing as a magnetic North Pole without a magnetic South Pole on the other side of the same magnet. The Fed is borrowing, absolutely, in order to lend, absolutely. They’re doing both. And it depends on which side of the trade you want to look at, to how you answer that question.
John: OK, so to our Homer Simpson moment. If the Fed is a borrower who, in fact, are the lenders to the Fed, and I’m going to give a little spoiler alert. You wrote a corollary article wherein there is a sign says, welcome to the poker room. And it says something to the effect of if you sit down and within the first hour, can’t tell who the sucker is, it’s you.
So, Keith, put a bow on this. Who is lending to the Fed?
Keith: It’s you. It’s everybody who desires the Fed’s credit paper and calls it money, and would argue vehemently when I say “That is not money, gold is money, and the Fed’s emitted paper is credit.” They would say, “That is money, you’re wrong.” And that would be a vehement, knockdown, drag out fight with virtually the entire world ganging up against poor old me on that particular one. Everybody, including the gold bugs. The gold bugs want the price of gold to go up.
How do they measure up-ness or down-ness in terms of the Fed’s paper? So they regard the Fed’s paper as money. Everybody wants money. Everybody is working their you-know-what’s off to get more of what they regard money. Everybody is dumping labor and products on the bid price in order to get more money, as they regard it to be money. And why are they doing that? Well, in part because they have to service their debts.
So if you’re a farmer, and you borrowed a million dollars to get into a farming business, you never pay it off, but you have to come up with whatever…if the interest rate is five percent on that loan. You have to come up with fifty thousand dollars a year to service it. And if you don’t service it, they’ll take your farm. And you probably signed a personal guarantee as well. So they’ll take your home and everything else you have, if you don’t service it.
So everybody is desperately trying to get their hands on dollars, which happens to be the Fed’s credit that makes them creditors. Not only does it make them creditors to the Fed, it makes them not only willing creditors to the Fed, it makes them eager and highly motivated creditors. They want to become bigger creditors to the Fed because they regard it as money and because they need the money in order to service their debts. Even the gold people, many of them just look forward to when the price of gold will go up so they can sell their gold and get more of the Fed’s credit paper and become a bigger creditor to the Fed.
But if you buy gold, you are leaving the realm of being Fed creditors. If you own gold, you’re not a creditor to anybody. That’s kind of the whole point. And when you sell your gold that you’re becoming a creditor to the Fed, and they’re only concerned with the price of that credit against the price of the gold, not really thinking about do I want to be a credit to this borrower, who is also at the same time the biggest creditor to the biggest profligate borrower in the world, which is the US government.
And over the last year, we’ve seen, assuming the Biden’s covid stimulus relief, whatever you want to call it, bill passes. You know, that profligate borrower has added something like five point five trillion dollars to a deficit that was already running at one point seven trillion dollars. So what is that? $7.2 trillion. They’ve dug the hole deeper, seven point two trillion worth this year compared to last year. And the Fed is the creditor to that borrower. And everybody that owns dollars is the creditor to the Fed. Not a powerful position to be in. Not where you want to be.
John: No, indeed.
Well, that’s all the time we have today. Please see our show notes again for the link to this article that we referenced. Your homework is to review it until you can explain it to a friend. It will be on the final exam. Thank you for joining us on The Gold Exchange.