12-9-08 $7 trillion

On September 21, the day Secretary of Treasury Hank Paulson asked for "authority to issue up to $700 billion of Treasury securities," the way we think about money changed forever. Now we are exasperated but hardly stunned when they talk about spending $7 trillion to fight the financial crisis and the recession.

That $7 trillion is a misleading and confusing number because the media is confusing two very different kinds of money: Treasury money and Federal Reserve money. They are also confusing two separate problems: an unprecedented banking crisis and a "great recession."

Treasury money is the kind of dollars that the Congress has to appropriate and that has to come from one of two sources -- taxes or borrowing. Treasury dollars are what constitutes the spending in the federal budget and they are spent to address the recession.

Consumers, investors and governments spend Treasury dollars in what is called the real economy or the part that produces real goods and services. This real economy has a solvency problem; the middle-class cannot pay its bills: the workers of America are insolvent. The consequences of this lack of purchasing power or aggregate demand is what is being called the great recession.

The stimulus package is aimed at this solvency/recession problem. The stimulus/bailout, with Treasury money for Fannie Mae and Freddie Mac, AIG and the other Wall Street firms, is supposedly benefiting the over-indebted middle class. That money went to buy mortgages, toxic securities and ownership in affected businesses.

Note that Paulson asked for "authority to issue Treasury securities," that is, to borrow in the New York money markets. That $700 billion, and a lot more, is going to have to be borrowed to overcome the recession and. That money will come from savers around the world, including the Chinese and Japanese governments. Someday it will have to be paid back

The Treasury money in the stimulus package becomes part of the national debt. The Treasury borrowing of $700 billion will be in addition to the $500 billion deficit that existed before the crisis began. The deficits in 2009 and 2010 will be in excess of $1 trillion.

Federal Reserve money, unlike Treasury money, can be created by the Federal Reserve, literally out of thin air. It constitutes the money supply (M1), the total of all currency and demand deposits like checking accounts. It funds the financial sector.

Our financial system works through banks which lend money that they receive from depositors, other banks or the Federal Reserve system. At present banks are not lending and money is not flowing to those that want to borrow even though money is available. Banks are also refusing to lend to each other. This is a liquidity problem -- not the same as the solvency problem.

The Federal Reserve is loaning the banks immense, previously inconceivable, amounts of money, trillions of dollars. The Fed does this, Genesis fashion, by saying, "let there be money."

The Federal Reserve is giving the bank's money they can lend hoping to get it flowing through the economy again. The banks, with some common sense, see no reason to lend when the economy is in the middle of a financial crisis and the worst recession in generations.

But the situation is not as bad as $7 trillion makes it look.

The saving grace is that much of the $700 million of Treasury money will be spent in the form of loans and the purchase of ownership rights. These can all end up as profitable investments by the federal government, making money for taxpayers.

The Treasury is purchasing and nationalizing Wall Street, the auto industry and who knows what else. We wouldn’t want to call it socialism, so we can call it something else, like community capitalism. The irony is that Republicans are doing it.

The financial crisis is a technical liquidity problem that accounts for those multiple trillions. Chairman Bernanke can be trusted to solve that in a year or so by simply dropping Federal Reserve money from helicopters.

Eventually the banks will begin to lend again and Bernanke will then, just as easily, take the money out of the economy.

The Treasury money in the stimulus package is only a stopgap. The solution to the great recession is to raise the average hourly earnings in the real economy. Stimulus packages that hand out Treasury money, bailouts that cut wages and short-term spending on physical infrastructure will merely lengthen the recession.

Something has to be done to tip the balance of power away from the wealthy to those who earn their income. This is the middle class solvency/recession problem.