Printing Power: The Central Bank and the State
Based on a speech at the Mises Institute Summit, Hilton Head, South Carolina, October 12, 2024.
“Printing Power” in our title has a double meaning: it can mean “printing power”—the power to print money which central banks have. But we will focus on “printing power”—the central bank’s money printing as an essential source of the power of the State, including of course the Federal Reserve’s printing to promote the power of the United States government.
The Fed is good at literal printing, exercising its monopoly of currency issuance granted by the government. It has outstanding $2.3 trillion in pure paper money circulating around the world, of which perhaps 45% or more than $1 trillion is held abroad. All the currency represents zero-interest rate financing of the Fed and the U.S. government. With interest rates at 5%, this means a potential profit of $115 billion a year for them by the Fed’s having issued the currency.
The Fed is also good at metaphorical “printing,” which is simply entering credits on its own books to the deposit accounts of banks. The Fed thereby creates money which it can use to buy the debt securities of the Treasury—in other words, to lend the printed money to the government. The Fed now has $4.1 trillion in deposits.
Together then, as of October 2024, there is $6.4 trillion of currency and deposits used to finance the American State’s programs, payroll, interventions, subsidies, and wars. The Fed can and does use its buying power to keep the interest cost of the government’s debt lower than it would otherwise be. At peak Fed in March 2022, the Fed owned $8.4 trillion in Treasury debt and government mortgage securities.
Because the central bank prints power for the State, virtually all governments want and have one.
The real first mandate of every central bank is to finance the government of which it is a part, thereby enhancing and promoting the State’s power. In addition to lending the government money, the central bank taxes the citizens on behalf of the government by creating inflation. Taxing by inflation transfers purchasing power from the People to the State without the bother of having to enact tax legislation. From the viewpoint of the government, the central bank provides a free taxing technique.
The ability to run budget deficits is key to the power of the State. It wants to keep paying soldiers, buying munitions, paying all the employees of the government bureaucracies, funding its projects, sending money to political constituencies and friends at home and abroad, even if it is out of money. But it won’t run out of money if it has its central bank to print up what it needs.
You will not find this real first mandate of central banks anywhere in the Federal Reserve’s copious public relations materials. You will find a lot of discussion about setting interest rates, the “dual mandate” of maximum employment and stable prices (now redefined by the Fed as perpetual inflation), fighting inflation, regulating banks, and promoting financial stability, but never a mention of the essence of central banking: financing the government.
Our colleague Joe Salerno has discussed the evolution of economists from critics to friends of state power. I will add that running deficits and printing money also allow the government to hire and pay more economists. As is often noted, the Fed itself is the country’s largest employer of Ph.D. economists.
The First Mandate in Central Bank History
The history of central banks clearly displays their link to government power as a constant theme. We will review a few examples.
First, the model and most important central bank in the world before it was displaced by the Fed was the Bank of England. Why and how was the Bank of England created? As we read in Bernard Shull’s excellent book on the Fed, The Fourth Branch[1]:
“In 1694, the British Parliament desperately needed funds to finance its [war] with Louis XIV of France. It accepted a novel plan to establish a bank that would raise capital and promptly lend it to the government at [a] bargain rate. In return [it] would be granted a charter. Thus the Bank of England came into existence as an instrument of war finance.”
It worked. As historian William H. McNeill, in The Pursuit of Power, his study of state power from the 11th to the 20th centuries, observes:
“The English invent[ed] an efficient centralized credit mechanism for financing war by founding the Bank of England. The result was to assure Great Britain of naval superiority throughout the early eighteenth century. Easy credit made it possible to expand the scale of British naval effort quite rapidly whenever a war emergency required.”
In America, Alexander Hamilton, the father of the First Bank of the United States, the ultimate progenitor of the Fed, wrote in 1781:
“Great Britain is indebted for the immense efforts she has been able to make in so many illustrious and successful wars essentially to that vast fabric of credit raised on the foundation [of the Bank of England].”
Nor was the lesson lost on Napoleon, who created the Bank of France a century behind his British antagonists. Organizing the bank in 1800, Napoleon rationally said he wanted a bank he could rely on to lend him money when he needed it.
When the Federal Reserve was established another century later, the Federal Reserve Board met in the Treasury Building and was chaired by the Secretary of the Treasury. It seemed less important then than now. For a state dinner in its early days, the Federal Reserve Board complained that its members were too far back in the order of entry with insufficient prestige. They took this complaint to the Treasury Secretary, who took it to the President, Woodrow Wilson. “They can come in after the fire department,” said Wilson.
Today the Fed is the leading financial fire department in the world, although as James Grant wittily added in the new Mises movie on the Fed, they are also the leading financial arsonist.
What really made the Fed’s reputation was its role in financing the American intervention in the First World War. Quoting Shull again:
“When the United States entered the war in April 1917, the System turned its effort to supporting the Treasury’s deficit financing. The Treasury’s plan was to sell securities at as low a cost as possible by arrangements with the Fed to provide for low-cost borrowing to purchase them. [The Fed] was enlisted in the marketing and promotion of securities. Banks were encouraged to borrow in order to purchase Treasury securities and to extend credit to their customers to do so. Preferential rates were established for borrowing from the Federal Reserve Banks to purchase government securities. The Federal Reserve Banks became great bond-distributing organizations.”
The Fed had energetically carried out its real first mandate. Said the Treasury Department appreciatively in 1918:
“Without [the Fed], it would be impossible to finance the tremendous credits required to assist the foreign governments making common cause with us against Germany, and to take care of the extraordinary expenditures entailed by our part in the war.”
Or you might say, the Fed was essential to financing America’s entanglement in the First World War, which led to immense growth in the size and reach of the Wilsonian U.S. government.
Said the Fed of itself:
“From the outset, [the Federal Reserve] recognized its duty to cooperate unreservedly with the Government to provide funds needed for the war and to suspend the application of well-recognized principles of economics and finance.”
To repeat, a key need of State power is ready and generous deficit financing. Most recently, this was evident in the gigantic deficits of the Covid financial and economic crisis and the vast subsidies of its aftermath, leading as we have said, to peak Fed in March 2022.
A “Masterful Manipulation”
We will end with a vivid example of the central bank printing power.
At the beginning of the crisis of the First World War in 1914, the Bank of England was the greatest central bank in the world. Yet the Bank engaged in fraud to deceive the British public in order to finance the British war effort.
The first big government war bond issue of the war raised less than a third of its target sales to the public, but this real result was kept hidden. “The shortfall was secretly plugged by the Bank, with funds registered individually under the names of the Chief Cashier and his deputy to hide their true origin,” we learn from a Bank of England article published a century later. In other words, the Bank of England bought and monetized the new government debt and lied about it to the public to support the government’s war plans.
The lie passed into the Financial Times under the headline, “OVER-SUBSCRIBED WAR LOAN”—an odd description, to say the least, of an issue with its allocation to the public in fact undersubscribed by two-thirds.
But responsible officers of the Bank of England and the British government thought speaking the truth would endanger future government borrowing and be a propaganda victory for Germany. The famous economist John Maynard Keynes wrote a secret memorandum to His Majesty’s Treasury, in which he described the Bank of England’s actions as “compelled by circumstances” and that they had been “concealed from the public by a masterful manipulation.”
A “masterful manipulation”! One very helpful to the British State, so it could get itself into the incredible disaster of the First World War.
To sum up:
Central banks are a terrific means to enhance the power of the State by printing power. They cannot be properly understood without this insight.
[1] The quotations I use are excerpts, with ellipses deleted.