TOPICS > Economy

When the Government Writes Checks, Where Does the Money Come From?

March 17, 2009 at 6:20 PM EDT
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With billions of dollars paid out or promised for financial industry bailouts and the stimulus bill -- and more requests on the way -- Paul Solman looks at where the government is getting the money to pay for the rescue measures.

JIM LEHRER: The rescue money source question comes from our economics correspondent, Paul Solman.

PAUL SOLMAN, NewsHour economics correspondent: Time and again, viewers like you have visited our Q&A Web site, “The Business Desk,” and asked the following Q: Where is the government getting all the money, several trillion dollars so far, for all its bailouts and stimuli?

Here’s the A: The government gets the money two ways, as we’re about to explain by putting it graphically.

The Treasury Department borrows money; the Federal Reserve creates it. We’ll start with the Fed and creationism and, this being PBS, with a bit of history.

Once upon a time, money — that most convenient stand-in for value — was itself valuable, often made of precious metals like gold and silver. Rulers minted the metals into coins and stamped them to vouch for their content, a kind of “Royal Housekeeping Seal of Approval.”

But with the industrial revolution came an explosion of new wealth. The supply of gold and silver couldn’t keep up; that shackled the trading of wealth and thus economic growth.

So folks came up with paper money: printed promises issued by rulers or rich merchants or banks redeemable for something precious, like gold or silver.

In fact, the U.S. government issued gold certificates from the 1880s to the 1930s. And as recently as the 1960s, all one-dollar bills and most fives and tens were silver certificates, payable to the bearer on demand.

Until recently, few wanted to meddle with the metals, preferring to trust the paper. After all, it’s a real hassle to store the shiny stuff, as we learned on a recent visit to a gold and silver dealer in Oakland, California.

CHARLIE MAMMOSER, Northern California Coin Exchange: I’ve had people come in, and they say, “I want to buy 10, 20, 40 ounces of gold.” And they take it away, and I tell them, “Don’t think you can hide it in the freezer, because crooks know to look there.” “Oh, no, I’m going to go put it in my safe deposit box.”

If the bank goes belly up, how do you get into your safe deposit box to get your gold that you bought to protect yourself from all this stuff?

PAUL SOLMAN: So Charlie Mammoser’s customers wind up spending their energy on camouflage.

CHARLIE MAMMOSER: I had a customer. He had some thousand-ounce silver bars. And what he did is he spray-painted them black, and he would use them as doorstops in his house. You could walk right by it and never know what it was.

Federal Reserve creates money

Edward Yardeni
Yardeni Research
That great, big sucking sound you hear out there is global capital coming into our markets.

PAUL SOLMAN: No wonder the less enterprising among us put our trust in Uncle Sam's money. But here's a source of confusion when it comes to that money.

It's not paper that the Fed creates when it makes the new money for its bailouts and the like. Relying on this oldly minted footage, as we TV folks do to visualize dollars, we tend to mislead folks. In fact, there's only $1 trillion or so worth of bills and coins out there at the moment worldwide, pretty much the same amount there was last year.

But there's another $1 trillion or so worth of Federal Reserves in the banking system, most of which have been created in the past 12 months.

We'd interviewed economist David Wyss recently at New York's Central Park Zoo, discussing the extent to which bearish psychology, a form of what's called animal spirits, has played a role in the bath we're all taking. We also asked Wyss, what's a Federal Reserve?

DAVID WYSS, chief economist, Standard & Poor's: All it really is, is an electronic transfer into the bank account. And if they want to buy mortgage-backed securities, all you do is send an electronic signal to the bank and get the securities and exchange.

PAUL SOLMAN: And then the bank has that amount on deposit from the Fed?

DAVID WYSS: That's what federal funds are. The Fed creates money. That's its job. That's a central bank's job.

PAUL SOLMAN: But what's the difference between minted money and Federal Reserves, we asked economist Simon Johnson?

SIMON JOHNSON, MIT Sloan School of Management: It's quite funny. The Federal Reserve insists, absolutely categorically, "We do not print money. That's the U.S. Mint that prints money."

But, of course, the Fed issues money. It's a great deal, right? Instead of having to print it on a printing press, you just do it digitally. It doesn't actually cost you anything, hardly anything to issue these new digits, these new bits of code on a computer somewhere.

PAUL SOLMAN: In other words, these Federal Reserves or federal funds are just digital promises, computer blips, not cash, but just as good, no different than the money in your checking account.

So the Fed is creating money, even if it's not minting it, something like $600 billion new electronic dollars in the past year. But that's not the only way the government is coming up with money to try to quell the crisis. It's also been borrowing money from investors all over the world.

EDWARD YARDENI, president, Yardeni Research: That great, big sucking sound you hear out there is global capital coming into our markets.

Foreign investments

Robert Samuelson
Author, The Great Inflation
There is a danger that, if they pump too much in, the ultimate consequence will be inflation, which they don't want.

PAUL SOLMAN: We caught up with economist Ed Yardeni at an investment breakfast a while ago.

EDWARD YARDENI: We're talking about investors around the world that are now focusing on the return of their capital than the return and their capital. They want their money back. And, apparently, they feel that the U.S. government is the best place to park their money right now.

PAUL SOLMAN: By U.S. government, Ed Yardeni means not the Fed, but the Treasury, which collects taxes and, if they fall short of federal expenses, borrows to make up the difference by selling its Treasury bills, notes, and bonds to investors.

Usually, the more it borrows, the higher the interest rate it has to pay to keep lenders lending. But investors have been so safety conscious of late, they've been willing to take almost no interest at all to stow their dough in Treasuries.

So the world's and America's investors are lending the government all this money?

EDWARD YARDENI: That's right. It's a very perverse situation that's really benefiting the United States. It's certainly easy to argue that we started this mess in the first place with all of our excesses, and you would think that foreigners would say, "You know, a curse on you. We don't want to invest in the United States anymore."

Quite the opposite. They're saying, "Take all of our money, and you don't even have to pay us anything. Just put it in Treasury bills. And do whatever you want with it; just make sure we get it back." And as a result, that's created this enormous benefit for us.

PAUL SOLMAN: The Treasury has borrowed $1.5 trillion in just the past year to cover both its annual revenue shortfall, the budget deficit, and the TARP, the Troubled Asset Relief Program, not including the newly passed stimulus, which will require another $800 billion or so and other new Fed programs.

But add it all together and you've got a couple of trillion at least in new Treasury borrowing and some $600 billion in new Fed money, thus far.

So that's where the money comes from, but it raises a new and pressing concern. With all this printing and borrowing, might there be too much money in circulation, risking inflation? That's worrying folks at the moment both left and right.

Bob Samuelson, author of "The Great Inflation and Its Aftermath," is sometimes thought of as conservative.

ROBERT SAMUELSON, author, "The Great Inflation and Its Aftermath": The Fed is clearly pumping huge amounts of money into the financial system to prevent a panic, to provide liquidity for institutions who need it. And there is a danger that, if they pump too much in, the ultimate consequence will be inflation, which they don't want.

PAUL SOLMAN: Former Nixon aide Kevin Phillips, proud author of "Bad Money," is now decidedly liberal.

KEVIN PHILLIPS, author, "Bad Money": You have the government spending these huge amounts of money in commitments they're making to bail everything out. It's all the money that's being given to the investment banks and banks that are in trouble at almost negligible cost. And they are allowed to come in and basically bring in a piece of some instrument that's almost worthless, and they get real money, insofar as our money is real money, for that.

Fear of hyperinflation

John Williams
If the foreign investors get to the point of dumping those dollars, the Fed's got to step in and intervene and start buying up the federal debt to keep the system from collapsing.

PAUL SOLMAN: The more the Fed does this, the more dollars out there, eventually raising the fear of hyperinflation: a $500 billion dinar note from the former Yugoslavia, famous photos from 1920s Germany, bales of bills of so little value people began using them to warm the house or go fly a kite.

It's happening in Zimbabwe today: money literally not worth the paper it's printed on. And so, if too much money is borrowed and printed in the U.S....

JOHN WILLIAMS, The dollar becomes effectively worthless. You see hyperinflation.

PAUL SOLMAN: Economist John Williams advises clients and runs the Web site, which contrasts his statistics with those of the government. He's worried that even our borrowing will have to be covered with new dollars.

JOHN WILLIAMS: There's a tremendous amount of dollars being held by foreign investors. And if the foreign investors get to the point of dumping those dollars, the Fed's got to step in and intervene and start buying up the federal debt to keep the system from collapsing.

PAUL SOLMAN: Which would mean the Fed creating more electronic money. But right now, there's too little money out there, because everyone's afraid to spend or lend. Again, David Wyss.

DAVID WYSS: When people take their money home, shove it under their mattress, that basically is removing money from circulation. The Fed has to replace it.

PAUL SOLMAN: Has to replace it to keep the economy from shrinking, and that's why the Treasury is borrowing so much and, says Simon Johnson...

SIMON JOHNSON: The Fed shoveling money in with a very big shovel right now, and they're making a calculation that this is the amount of money that sort of balances the system. You don't get a lot of inflation.

In fact, if anything, prices are tending to fall. We're tending to get deflation. But this could turn very, very quickly. And all of a sudden, there's all that money out there, and that's what people are worried about.

PAUL SOLMAN: People like Charley Mammoser and his customers, like John Williams.

JOHN WILLIAMS: I buy coins. I prefer gold coins as a hedge against inflation, because, long term, we have a terrible inflation problem ahead of us.

PAUL SOLMAN: Long term, maybe we do, maybe we don't. Short term, though, we've got deflation, which is why the government is both printing and borrowing money right now to try to get the economy up and running once again.