Where Did US Dollars Come From?

Continuing in the same spirit as my prior post, let me draw from another Modern Monetary Theory (MMT) talking point making the rounds on Twitter. In contrast to arguments over interpretation or framing, in this particular case the MMTers are simply wrong. Specifically, they keep assuring the public that the stockpile of US dollars could only have come into existence through prior episodes of government deficit spending. But this is simply not true; originally, official US dollars consisted of gold and silver coins.

The MMTers Smugly Rely on Bogus History

Here is a screenshot showing the chortling the MMTers enjoyed with their rhetorical questions about the origin of US dollars:

To understand the above: The “call-151” account was mocking the standard conservative/libertarian talking point that claims government can only spend what it first receives from the taxpayers. In contrast to this ostensibly naïve view, call-151 agrees with the MMTers, and thinks it’s obvious that US dollars could only be in the hands of the taxpayers if they had first been spent by the government, thus bringing them into existence. In the MMT framework, government deficits create dollars and add them to the system, while government surpluses destroy money and remove it from the system.

Going along for the ride, “Patricia”—who is a PhD candidate and hosts a podcast devoted to MMT—whimsically (and tongue-in-cheek) likens US dollars to the roaming buffalo. Then Mr. Triana chimes in, with less whimsy, by claiming that the orthodox economists—unlike the MMTers who understand basic accounting—are ironically the ones committed to the idea that money must have come from nature, since (he thinks) the orthodox economists stubbornly refuse to admit the basic truth that government deficit spending is the source of all money.

History Has a Hard Money Bias

There’s just one little problem with all of this banter: It’s utterly, demonstrably wrong. In prior posts (first and second) at this blog, I used the Fed’s balance sheet to show that even if the federal government paid off its entire debt, there would be net dollars remaining in the system. So this proves—at least for honest commentators—that the current stockpile of US dollars can’t be the result merely of prior government deficit spending.

However, more fundamentally, we can refer to the early period of US monetary history. As I explain in my book (which is free online), the US authorities didn’t even issue official US dollars in the form of paper currency until the Civil War. Before then, official US dollars consisted exclusively of gold and silver coins, such as a $20 “double eagle” gold coin, or a quarter-dollar silver coin (“quarter” for short), etc.

Now it’s true, during this early period private banks could issue notes that were denominated in US dollars. But these were not the same thing as official US dollars, both economically and legally. Even the Second Bank of the United States—which is considered the precursor to the Federal Reserve and which Andrew Jackson famously “killed” in one of his signature policies—couldn’t issue notes with legal tender power. In normal times, paper banknotes often traded at par with official US coinage, but during a crisis it became clear what was really the money and what was a mere claim on it.

Why Do Banks Fail?

In closing, let me pose a riddle to those who like to argue that “private banks create most of the money” or that “reserve requirements are a thing of the past” or that “central banks don’t really have much control over the money supply.” You hear these types of statements all the time on social media. There is a germ of truth in them, but the people expressing these sentiments often take things too far. 

Specifically, for those who think that private banks create money on the same footing as the government, here is a riddle: Why do private banks ever fail? For example, if there’s a bank run, why doesn’t the bank just “create more dollars,” if it supposedly has the power to do so?

And notice you can’t explain the puzzle merely by pointing to a few “irrational” depositors. If a bank really can “create dollars” the way some of the people on social media believe, in the event of some of their clientele getting spooked, why can’t the bank simply “create dollars” and use them to obtain actual cash from other financial institutions, who are just as savvy as the MMTers?

The answer, of course, is that IOUs from a bank—even a household name like Citi or Chase—are not economically or legally equivalent to official US dollars. That’s why even large banks can go down. This simple observation shows how much of the commentary on social media regarding “private money creation” is woefully incomplete. For a fuller account, I suggest my book.

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