Tag Archives: Federal Reserve

Money 3.0: Cryptocurrencies

Recently, Jamie Dimon called Bitcoin a ‘fraud’. This coming from the CEO of JP Morgan, the bank that has been fined more than any other, save one, for financial crimes since the Great Recession of 2008. His statement reeks of hypocrisy since JPM is a member of the Enterprise Ethereum Alliance, his traders have been trading Bitcoin related ETN securities, and his firm has applied for patents using blockchain technology.

By the way the Enterprise Ethereum Alliance has well over 100 members including Microsoft and Mastercard. Serious players understand that cryptocurrencies are a big deal. The market cap of all cryptocurrencies is currently in the neighborhood of $150 billion, around 2/3 the market cap of Visa. And this has all happened in only eight years’ time.

So why do I say cryptocurrencies like Bitcoin and Ethereum are Money 3.0? And what are Money 1.0 and Money 2.0?

First what is Money? It is amazing how few people can give a definition, other than pulling out a bill from their wallet, or referring to the numbers in their checking account statement. And how does money get created in our modern economy? Very few actually understand the process. Most people say government creates it. Governments can, and do, but most money is not created directly by the government. What the government does is validate money, they define a single type of money for their nation. They print currency, but most money today is digital, residing in bank balance sheets, and most money creation occurs as banks issue new loans.

Throughout history there have been many forms of money, but two forms have dominated. The first form, Money 1.0, was the dominant form for millennia. It was coins made of precious metals, in particular gold and silver, and ‘base’ metals such as copper and bronze. According to the St. Louis Federal Reserve, money must have six properties: durability, portability, divisibility, uniformity, limited supply,  and acceptability.

They sound a bit like goldbugs when they write it that way. These are all useful attributes of the thing that is used for money, be it gold or paper. But it doesn’t quite get to the most essential three properties of money. It must serve as:

1. A unit of account

2. A store of value, and

3. A medium of exchange

Money is whatever can be used as a socially agreed upon unit of account and medium of exchange. It also should retain its value, not depreciate quickly, so that it can be used next month and next year as well. Notice I say socially. Societies agree upon what is used as money, and nation states in recent centuries have taken the lead in that definition. In order to be conveniently exchanged, then the six properties above come into play. Durability and limited supply allow the retention of value. Portability and divisibility make it easier to exchange. Uniformity makes it a useful unit of account, as does acceptability.

We all have to more or less agree on what the accounting unit is. That is actually the starting point for money, agreeing on the standard measure. The government can decree the accounting unit, and can demand taxes be paid in that unit. That is government fiat, and can apply for either coined money of precious or base metals (Money 1.0) or paper money (Money 2.0).

Roman gold Solidus coin. York Museums Trust. CC-BY-SA 4.0

The US dollar was originally defined to contain a certain weight of silver, and aligned to the Spanish dollar (originally Austrian  thaler) or ‘pieces of eight’ that was widely used in New World trade. The US dollar has also been defined against gold, with an official act in 1900 following nearly 3 decades of defacto gold standard following the Civil War. Of course the gold standard is now entirely gone after being discarded in two phases, under Roosevelt in 1933 and Nixon in 1971. The remnants of the bimetallic standard of the late 19th century remain in present-day dimes and quarters that used to contain silver even until 1965, retain the color, but have been entirely debased.

No nation remains on a Money 1.0 standard of precious metals, all have moved to Money 2.0, fiat paper money. If they did they would lose their gold, and they prefer to melt it into bars and store it in central bank vaults as a reserve. So as Warren Buffet says, we dig it up in mines, melt it down into bars, and bury it again in vaults.

With paper money, there must be fiat, as nobody wants pieces of paper that have no value. The days of gold certificates and silver certificates as circulating currency are long gone, although I remember silver certificate dollar bills from my youth. The value comes from the legal tender requirements that the paper be accepted by businesses, be used for taxes, and from the government’s printing process to make counterfeiting difficult plus the government’s overall management of the money supply (usually through interest rate policies) to limit loss of value due to inflation.

The technology of high quality paper engraving, augmented with serial numbers, threads and holograms, and the technology of central banks, allow fiat money to work. The vast majority of nations have central banks to lend to the commercial banks in times of crisis and to manage the banking system and money supply indirectly.

So those are Money 1.0 and Money 2.0. In summary:

Money 1.0 – Public or private, asset-based, intrinsic value, coins or bars of precious metal

Bureau of Engraving and Printing, U.S. Dept. of Treasury

Money 2.0 – Public and sovereign, debt-based, no intrinsic value, paper and digital.

Most Money 2.0 is digital, with the circulating currency representing a small percentage. Money mostly comes into circulation not through the printing press, but when banks make new loans. If a bank creates an auto loan, it credits the checking account of its customer digitally. Banks are allowed to make new loans within the limits of their central bank authority determined reserves and equity capital requirements.

Note as an aside that Money 1.0 and Money 2.0 can coexist. We mostly have Money 2.0 in the United States, but there was a small amount of silver coinage money circulating alongside up until the 1960s. This is an important principle, since we are beginning to see the coexistence of Money 2.0 and Money 3.0.

What about Money 3.0? Cryptocurrencies are purely digital, whereas Money 2.0, fiat and debt-based money, is mostly digital.

Why Money 3.0? Technologists and advocates of non-fiat money were concerned about the risks of centralized monetary systems dominated by central banks and by money center banks engaged in fraudulent activities around mortgages and other lending with derivatives including CDOs, CDSs and more. The corrupt system lead to the Great Recession of 2008. Everyone in the society suffered, but the banks were bailed out by enormous government loans.

There were more than 50 attempts at creating a digital crypotcurrency prior to the year 2000. None succeeded. One was gold-based and known as e-gold. It was shut down in 2009 by the US government, because it ran afoul of stricter money laundering regulations. It was also subject to repeated thefts of accounts from Russian and other criminal hackers.

A successful non-fiat cryptocurrency must provide a single secure ledger of entries to protect against counterfeiting and double spending. It must have a method of commiting a single instance of a transaction to this secure ledger that is publicly shared, and is known as the blockchain. It must have a built-in automated “central banking” function that determines the money supply.

Satoshi Nakamoto’s brilliance was to combine a number of existing ideas around public/private key cryptography, distributed ledgers, and a mining algorithm with “proof of work” that rewarded miners for solving a difficult cryptographic hash problem. Transactions are signed with private keys. All bitcoins reside in the distributed ledger. The owner has a wallet with the key that allows them to transfer bitcoin in arbitrary amounts to someone else and thus confers ownership.

The supply is limited with a maximum at 21 million bitcoins that will not be reached until well into the 22nd century. New bitcoin comes into existence in conjunction with the mining of blocks of transactions. The successful miner is rewarded with an allocation of new coins, presently 12.5 coins per block of approximately 2000 transactions. So here we have the central banking function and a digital minting or mining process for the ‘coins’ which are really just ledger entries.

We describe this Nakamoto consensus algorithm and the mining process in more detail at orionx.net/podcast.

Now we have not just Bitcoin, but Ethereum, Bitcoin Cash (which is a recent fork of Bitcoin with large block size), Ripple, Litecoin and hundreds more cryptocurrencies. We have new coins being created rapidly in conjunction with new applications and ICOs – initial coin offerings.

The largest of these, those with market caps in the billions of dollars, meet the three requirements for money. Unit of account. Medium of Exchange. Store of value. Their limitations at present relate to the latter two attributes. They are accepted as medium of exchange in some environments, but relatively few compared to existing fiat currencies. And as a result of that their value is less stable and determined more by investment and speculative demand. Their ultimate value will be determined by the cryptocurrency economy as uses cases, applications, and acceptance grow.

They are child currencies, developing and growing, but far from the maturity of an existing national fiat currency. The value should continue to grow for the long term, however since transaction volumes are increasing very rapidly.

So now we have in the world:

Money 3.0 – Private and globally distributed, asset-based, digital only.

Money 3.0 holds much promise. It can remove a lot of cost and friction from the financial system. Trying sending a check or ACH transfer to your sister and having the transaction complete on the weekend. Send her some bitcoin? She will get it even on Sunday at 3 am around an hour or so after you send it. Bitcoin is 24 by 7 by 365. And with very limited fees within the Bitcoin economy. Most of the cost is in moving Bitcoin to fiat or vice versa.

It is not based on debt, so does not have the instability of debt or counterparty risk. The only real risk is security, which holds as well for your banking balances. The other risk is to the value as governments and politicians feel threatened. But at the end of the day, they can only regulate it, but not eliminate it. The technology is too widely available to anyone.

Money 3.0 is not poised to replace Money 2.0 anytime soon, although in a number of ways it is superior. They will coexist. At some point a small country will convert their currency to Money 3.0, by building a blockchain-based peso or some such. A number of central banks, large and small, are already studying this issue.

Many have talked about global currencies in the past. The US dollar has global impact for trade and the price of key commodities, but you have to exchange it when you cross borders. The Euro has been a boon for commerce, trade, and travel in many countries within Europe. Gold historically had a global role but was difficult to move and verify as to weight and purity.

Bitcoin has no weight and purity issues. It transcends borders. It, Ether, and the other cryptocurrencies are indeed the first global currencies.


Inching closer to a US recession, while Yellen is eager to hike

Today we got the Minutes from the December 15-16 FOMC meeting where the Fed hiked interest rates.  That in itself is not terribly interesting and there is not much news in the Minutes to shock the markets. Nonetheless it is another day of tightening of US monetary conditions – stronger dollar, lower inflation expectations, lower […]


The Citadel Is Breached: Congress Taps the Fed for Infrastructure Funding

In a landmark infrastructure bill passed in December, Congress finally penetrated the Fed’s “independence” by tapping its reserves and bank dividends for infrastructure funding. The bill was a start. But some experts, including Congressional candidate Tim Canova, say Congress should go further and authorize funds to be issued for infrastructure directly. For at least a […]


Inching closer to a US recession, while Yellen is eager to hike

Today we got the Minutes from the December 15-16 FOMC meeting where the Fed hiked interest rates.  That in itself is not terribly interesting and there is not much news in the Minutes to shock the markets. Nonetheless it is another day of tightening of US monetary conditions – stronger dollar, lower inflation expectations, lower […]


Yellen is transforming the US economy into her favourite textbook model

When you read the standard macroeconomic textbook you will be introduced to different macroeconomic models and the characteristics of these models are often described as keynesian and classical/monetarist. In the textbook version it is said that keynesians believe that prices and wages are rigid, while monetarist/classical economist believe wages and prices are fully flexible. This […]


Web of Debt – Book Review

Web of Debt, by Ellen H. Brown, is a fascinating treatment of the monetary history of the U.S. and a revelation of how money is created in modern monetary systems. She writes in an engaging and highly readable style about one of the most critical issues that runs through all of American history from Colonial times through today with the financial crisis and Great Recession. There are no equations that I recall, a handful of charts, but mainly a lot of well-researched history and interesting anecdotes.

You can listen to an audio of the book’s Introduction here: http://www.webofdebt.com/media/WebofDebtintro.mp3.

There have been continuing struggles in the U.S. over the type of money, private or public, and gold, silver or paper, throughout the past 250 plus years. She focuses particularly on the time from the Civil War until present day. Who creates the money is just as important, if not more so, than what type of money we have.

Most money, including that in your checking or savings account (CD) resides as digits inside computers and not as stacks of bank notes, which represent only a few percent of the total. Money is created almost entirely by private commercial banks, not by the Treasury department, and not by the Federal Reserve (although the Fed does create monetary reserves or base money)[1]. But money in general, the money we know and love and use in the real economy, is created out of thin air by banks as a direct result of the process of making loans to individuals and companies. The banks create most of the money supply and the Fed creates the underlying bankers’ money.

Thus money is debt and debt is money. If loans outstanding expand, so does the money supply; if loans contract, the money supply contracts. With all the discussion currently around the “fiscal cliff” recently it is critical to understand that if the US government debt were to be paid off quickly, the money supply would shrink to a fraction of its present value, completely undermining the economy and causing not only a very severe depression but untold suffering.

The Fed has worked in recent years to try to increase the money supply in order to avoid deflation and depression and ameliorate unemployment. But they have been having a hard time of it, because it’s the banks and the players in the economy that have the real control. As banks foreclose on mortgages or write down loans the money supply decreases. As they tighten lending standards and as consumers and corporations cut back on borrowing and sit on cash, the money supply stops expanding or falls, and the velocity, or rate of turnover contracts.

Now this money created as debt is leveraged through the “magic” (or fraud) of fractional reserve banking. Banks are allowed to create 10 times or more money in loans than they have as reserves at the Fed. This is the “secret” of fractional reserve banking.

The book begins with, and almost revolves around, the story of the Wizard of Oz, written by Frank Baum. This is not just a child’s story, or a great American fairy tale, but actually was written purposefully as an allegory about the monetary battles in the U.S. at the end of the 19th century. For example, in the Wizard of Oz the yellow brick road represents the gold standard. When Dorothy throws water on the Wicked Witch of the East (the New York banking interests led by J.P. Morgan) it represents liquidity (greater money supply) which melts the witch.

Prior to the Civil War the US was on a bimetallic standard, that is, both gold and silver coin were minted. Paper money was issued by state-chartered banks. During the Civil War the US was on a national fiat money standard with the issuance of paper money (Greenbacks). But in 1873 the US reverted to a gold (only) standard.

As a result, in the post Civil War period, the bankers were able to keep credit tight and farmers were heavily in debt and often facing foreclosures by the banks. There were repeated booms and busts and the economy was generally deflationary, due to an insufficient money supply. A fight emerged between the Eastern banking establishment’s support of the gold standard, and their desire to keep the money supply restricted, and alternatively, the demand for greater coinage of silver or issuance of Greenback US Treasury notes as alternatives advocated by farmers and laborers for greater liquidity (and better prices for agricultural products).

There was no Federal Reserve during this time, that didn’t come until 1913, approaching the eve of World War 1. Coinage was created by the Treasury (US Mint) but was insufficient, there were Greenbacks in circulation, and there were Gold certificates (back by gold coin), Silver certificates (backed by silver coin) and Treasury notes (back by government bonds).

Gold and silver coins, and our modern coins represent debt-free money. In addition Greenback US Treasury notes were also issued as debt-free money. So either paper money or coin money can be debt-free.

In contrast, today’s Federal Reserve notes are backed by US Treasury bonds or agency bonds held by the Fed and are thus debt-laden money. US coinage, amounting to less than 1% of the money supply and issued by the Mint, is debt-free.

Ellen Brown’s fine book helps you understand these issues, and how the private banks struggled to grab control of the monetary system away from the US government. They won the battle in 1913 with the creation of the Federal Reserve system[2], and further consolidated their control with the elimination of the gold standard in 1971 by President Nixon. The value of the dollar has fallen by over 23 times (what was a dollar has shrunk to 4 cents) since the Fed was established because the bankers get to touch the money supply first, and continually earn interest on it, and thus it is in their direct interest for it to expand continuously, even faster than necessary to support population and productivity growth.

Federal Reserve Notes, legal tender for all debts public and private, note Green seal on right front side (and they retain the green back of Lincoln’s debt-free US Treasury notes).

In fact, in a debt-based money system, there is no real alternative, since loan principal must be paid back with interest added on top. When loans are created the principal is created, but not the interest! If the majority of people are going to be able to pay interest and principal fully on their mortgages and car loans and credit cards, then the money supply must continually expand. The Fed has indirect influence over the supply of money through direct market operations and the influence over interest rates, especially short-term rates, but not the ultimate control. (Thus the expression “pushing on a string” especially when short-term interest rates are near zero.)

Web of Debt is a great place to start to understand these issues, or for those who have a good understanding already, to get another perspective. The explanation of the tie-in to the Wizard of Oz[3] allegory is very interesting. Towards the end of the book she explores alternatives to our current system, such as the elimination of fractional reserve lending, and bringing the Federal Reserve system within the Treasury department, thus enabling a return to Treasury issued debt-free money. The government debt could be retired over a period of some years by paying the interest and principal as they came due with debt-free US Treasury issued Notes. This is not a radical idea, below is the image of a US  Note issued as recently as 1963, and which I remember in circulation when I was much younger (note the distinguishing red seal and red numbers and United States Note at the top). In reality, such US Treasury Notes would be primarily in the form of digits inside computers, just as Federal Reserve Note-based money is today.


The book is available through the author’s web site, Amazon and elsewhere in physical or e-book format.

Sections in Web of Debt:

  1. The Yellow Brick Road: From Gold to Federal Reserve notes
  2. The Bankers Capture the Money Machine
  3. Enslaved by Debt: The Bankers’ Web Spreads over the Globe
  4. The Debt Spider Captures America
  5. The Magic Slippers: Taking Back the Money Power
  6. Vanquishing the Debt Spider: A Banking System that Serves the People


[1] These monetary reserves are used exclusively between banks and the Federal Reserve. Individuals and non-banking corporations cannot have accounts at the Federal Reserve, only banks in the system can. Monetary reserves theoretically provide some limit on how much money banks can create through reserve requirements, but in practice have little effect since banks can and do lend reserves to one another. This monetary base can be said to support the much larger stock of money used in the economy and around the world.

[2] Is the Fed public or private? It’s a hybrid. Some call it the fourth branch of government, but in many ways it stands outside of the government, although in practice it coordinates with the Treasury. There are 12 regional Federal Reserve banks in the system; they are fully owned by the member banks, not by the government. The member banks, not the government, own the shares and receive dividends. The NY Fed is first among equals, it engages in the monetary operations in concert with the commercial banks centered in New York. The system has oversight by the Chairman and the Board of Governors whose members (generally bankers or academic economists) are appointed by the President, and who report to Congress regularly. Profits of the Federal Reserve system are returned to the US Treasury. But the Fed guards most of its operations in secrecy and is not fully audited.

[3] What is Oz? Simply, Oz = oz. = ounce, as in ounce of silver, or ounce of gold.

Modern money is Debt

“When you get in debt you become a slave.” – Andrew Jackson

Modern money is debt and debt is money. Almost all money in the Anglo-American system which predominates in the developed world is created as the result of private banks making loans. This blog will discuss issues and contemporary developments in our highly leveraged financial system. Banks today are the money creators. Not only do they create money even beyond the bounds of fractional reserve banking, but they also have participated and enabled a huge shadow banking system which has made the system even more unstable and more difficult to understand and regulate by the central banks and national authorities.

The wealth destruction since the onset of the financial crisis and the Great Recession has been massive due to this inherent instability and very high leverage. It is essential to understand clearly developments such as quantitative easing by central banks. Are they creating too much money which will lead to excessive inflation, or are they just trying to backstop the monetary destruction that occurs as defaults continue, as individuals increase savings, and as loans get paid down. Or is what they are doing ineffectual since creation of monetary reserves doesn’t in and of itself force the banks to expand the money supply through lending?