Economic Mythology

On The Sales of Indulgences & Treasury Bonds

This essay is part of a series comparing the twilights of (1) Rome's slave-based economic system and (2) the Middle Ages' feudal system to (3) today's capitalist economic system. In addition to the broad life cycles of these economic systems, we'll note similarities between infectious diseases and changes in communication technologies common to all three eras. Finally, we'll see how belief systems rise and fall in tandem with these broad economic systems. When these systems seize up and stop functioning, people begin questioning authority. And that, in turn, leads to collapses of bedrock conceptions of reality itself.

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Introduction

Economic classes have been a fixture in every society throughout history. These classes relate to each other hierarchically so that some classes are “elevated” above others. In this sense, elevation refers to the direction of the flow of wealth. The lower classes generally owe money to the upper classes just so they can participate in society. Through financial instruments such as rent or interest payments, the upper classes find ways to avail themselves of any wealth the lower classes might be in possession of. Since these payments cannot be justified by economic necessity, they’re backed by religious belief instead. As was the case with the infamous Sale of Indulgences during the Middle Ages, economic mythology facilitates transfers of wealth from poor to rich.

The Sale of Indulgences

During the Middle Ages, the European population uncritically accepted the Roman Catholic Church’s every dictate as bedrock reality. And the Church couldn’t resist abusing their absolute authority.

The most famous example was the so-called “Sale of Indulgences”. The Catholic Church forgives sins for free. But during the late Middle Ages, it grew obscenely wealthy by selling relief from lengthy sentences in Purgatory. This corrupt practice was the main complaint of Martin Luther, who touched off the Protestant Reformation by nailing his criticisms to the door of his local church in 1517.

The Church derived the authority to define reality from the popular belief that it was in exclusive communication with God. But it couldn’t resist the temptation to mold that popular belief into a shape that was highly lucrative for the Church.

This historical episode reveals a timeless economic connection between authority and reality. We like to think of ourselves as substantially more enlightened than the population of Europe during the Middle Ages. But just as the Roman Catholic Church fleeced its flock, our modern authorities still define reality for us in ways that are economically advantageous to them.

Fractional Reserve Banking

It’s commonly believed that when we take out a mortgage at our local bank branch, we’re borrowing the money of some thrifty depositor. This “load-bearing” belief supports the modern banking system and, therefore, modern society as a whole.

And it’s not true. When they make loans, banks create money out of thin air. They populate a spreadsheet with a few keystrokes and then charge us interest on the result. Our Fractional Reserve banking system amounts to counterfeiting.

Notice that your debit card can always be approved for the full balance in your checking account, even though your bank purports to loan out your money behind the scenes. If they were actually lending out your money, the bank would also draw down your account balance to reflect the missing funds.

Instead, the alchemy of Fractional Reserve banking means that your money can be in two places at once. Depositors retain full access to their money, even after their bank makes some or all of it simultaneously available to loan customers. Banks can get away with this double-counting forever, so long as their depositors don’t attempt to withdraw all their money at once in a classic “bank run”.

When loan customers spend borrowed money, it typically ends up deposited in another bank account. Those fresh deposits then become an occasion for banks to issue even more loans, which are also deposited somewhere so the process can repeat again. It’s commonly accepted that 97% of all currency comes from this multiplicative process of lending and redepositing that churns at the heart of Fractional Reserve banking systems.

The Money Supply

Management of the money supply means maintaining a reliable ratio between (1) the volume of currency and (2) the volume of goods and services offered in an economy. Inflation and deflation occur when this ratio is not kept constant.

Maintaining this ratio is most easily achieved by tailoring the volume of currency to match the volume of goods and services measured by that currency. Removing money from circulation is simple: taxation. In America, the Federal Government regularly removes currency from circulation by taxing it.

In fact, management of the money supply is the only reason a currency-issuing government would ever need to tax anyone. The Feds are in possession of the press that prints dollars. Why would they ever need to tax back a single one of our dollars when they can simply make their own? The answer is that they don’t, except to prevent inflation—by removing excess dollars from circulation.

On the other side of the ledger, government spending introduces dollars into circulation. Before the Feds can collect their first dollar back in taxes, they must print and spend dollars to seed the economy.

The key insight here is that spending is not constrained by taxes collected, as in a household budget, but rather that taxation is limited by spending.

The only practical limitation on spending is the risk of inflation. The Federal government has the printing press; it has no more of a limitation on the number of dollars it can create than a carpenter has a limitation on the number of inches they can use to frame up a house.

Treasury Bonds

The simple observation that the government must distribute money before it can collect any back in taxes is a powerful one. It exposes the false belief that the “national debt” is something that can or should be paid off.

In the 1990s, the Clinton Administration ran a budget surplus. That means they removed more dollars from the economy than they introduced. Between 1998 and 2001, half a trillion dollars vanished from the US economy in exactly that way. It’s no coincidence that the dot-com bubble burst shortly thereafter, and a deep recession ensued. When you stop thinking of the Federal budget as a household budget, it’s easy to see why.

In order for a single dollar to be left over for private sector use, there must be a difference between (1) dollars created through spending and (2) dollars destroyed through taxation. Private sector savings and the national debt are one and the same; both terms refer to money that was created by spending but never taxed back. The national debt reflects our national wealth like a mirror; we want it to be as high as possible.

However, certain economic factions within American society would have us believe that the national debt poses a serious threat. They point out that interest on the national debt will be greater than defense spending in 2024. And they’re correct.

During WWII, the US government marketed “Liberty Bonds” to the general public. It did not issue these bonds because it needed the cash; the government was already printing money hand-over-fist to finance the war effort. It issued the bonds to dampen the inflationary effect of all that spending—by temporarily removing excess dollars from circulation. Essentially, the buyers of Liberty Bonds agreed to not spend their savings for a few years in exchange for a little extra money.

We allow the most affluent among us to take a similar deal in lieu of taxation. Interest on the national debt exists only because we’ve been conditioned to think of the difference between (1) dollars created through spending and (2) dollars destroyed through taxation as a “debt”. The Treasury pays this debt by auctioning off financial instruments called “Treasury Bonds.”

By the end of 2024, we will have paid the already affluent a whopping $892 billion in interest alone for the pleasure of borrowing their money—more than the entire annual defense budget for the same time period—when we could have just taxed it off of them for free.

Conclusion

During the late Middle Ages, the Roman Catholic Church led its flock to believe that payments to the Church could get them out of Purgatory. This self-serving piece of economic mythology made the Church unfathomably wealthy. We still live with similar self-serving pieces of economic mythology today. Chief among them are the notions that banks loan out depositor’s money and that the “national debt” is something that can or should be paid off. Through money creation and interest payments, these two economic myths account for an upward flow of wealth that would have no economic justification otherwise.

Further Materials

Contrary to popular belief, the U.S. government can’t “just print money,” because American money is not issued by the Federal government at all, but by private banks, under the aegis of the Federal Reserve System. The Federal Reserve, in turn, is a peculiar sort of public-private hybrid, a consortium of privately owned banks whose Governing Board is appointed by the U.S. president, with Congressional approval, but which otherwise operates autonomously. All dollar bills in circulation in America are “Federal Reserve Notes”—the Fed issues them as promissory notes and commissions the U.S. mint to do the actual printing, paying it four cents for each bill. The arrangement is just a variation of the scheme originally pioneered by the Bank of England, whereby the Fed “loans” money to the United States government by purchasing treasury bonds, and then monetizes the U.S. debt by lending the money thus owed by the government to other banks. The difference is that while the Bank of England originally loaned the king gold, the Fed simply whisks the money into existence by saying that it’s there. Thus, it’s the Fed that has the power to print money. The banks that receive loans from the Fed are no longer permitted to print money themselves, but they are allowed to create virtual money by making loans ostensibly, at a fractional reserve rate established by the Fed—though in practice, even these restrictions have become largely theoretical.
David Graeber, Debt: The First 5000 Years, 2011, page 365