Transcript

423:

The Invention of Money
Transcript

Originally aired 01.07.2011

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Prologue.

Ira Glass

It's This American Life from WBEZ Chicago distributed by Public Radio international. And today's show begins with a question that somehow independently popped up in the heads of five different people all around the same time. The people were Caitlin Kenney, Dave Kestenbaum, Alex Blumberg, Jacob Goldstein, and Adam Davidson. All of them cover economics for our show and for NPR news as part of the Planet Money project.

Caitlin Kenney

It was in November of 2008.

Male Speaker 1

Yeah, it was in December of 2008.

Male Speaker 2

It was in the heart of the financial crisis.

Jacob Goldstein

Lehman brothers went bust.

Dave Kestenbaum

You were hearing on the news every day, all these like crazy numbers. X trillion dollars lost when the housing bubble popped. A trillion dollars disappeared from the stock market this week.

Male Speaker 2

My family members, my wife, my friends, people were just asking me, where did that money go? Who got it?

Dave Kestenbaum

You know, was there a black hole it went into? Was their a big fire somewhere, which burned up a lot of dollar bills. Where did the money go? I spent a long time thinking about that.

Ira Glass

All these reporters but Adam were pretty new to reporting on money and finance at the time. And that last reporter you heard, Kestenbaum, went online and bought some play money so we could run little scenarios, pretending that person A took out a loan from person B to buy a house from person C to try to understand where all the money went when all the housing prices collapsed. Jacob meanwhile, went to dinner with an aunt of his.

Jacob Goldstein

My aunt is an MBA and was a very successful businesswoman and made a lot of money. And I actually asked her because this idea that trillions of dollars could disappear from the stock market was confusing to me. And so I said where did all that money go? And she said, money is fiction.

Ira Glass

What does that mean?

Jacob Goldstein

Well, I guess it was the fact-- like it would have been one thing if a yoga teacher or something said that to me. But this is like my businesswoman aunt.

Ira Glass

Money is fiction. So the answer to the question, where did the money go when the housing market collapsed turns out to be that the money never existed in the first place. All those houses used to be worth a certain amount and now they were worth a lower amount. Simply because that's what everyone now agreed. No money changed hands, no many vanished. Same with retirement funds and stock portfolios. Alex says that this is when he realized that no where was safe. That there were inflation even sitting in the bank. All his money value could just slowly vaporize. Money is not solid. Its value could disappear. And all these reporters says that after that they would be working on what seemed like perfectly ordinary stories asking straightforward questions and they would bump up against this weird, fictional quality that money has.

For example, Kestenbaum says he was doing a story and he came upon this.

Dave Kestenbaum

One question is how much money is out there in dollars? You would think we track that among all things, right? And yet, it's a really complicated question to answer.

Ira Glass

Why is that so complicated?

Dave Kestenbaum

You could imagine trying to answer it by asking everybody like how much money do they have. So you open your wallet, there's cash in there. And then you'd also probably add your checking account and your savings account. But the money in your checking account and your savings account, the bank is a bank. What it does is it takes that money in-- your money-- and then it loans it out t some guy who wants to open a shoe shining store down the street. So he's holding your cash.

Ira Glass

Oh right. So the question is, how do you count that money without double counting it? Are you counting me having it or are you counting him having it?

Dave Kestenbaum

How do you handle that? And it gets really complicated because think of that guy who's opening that store who borrowed the money. He's going to pay someone to make a sign for him. That person's going to deposit some of that money in the bank. The bank's going to then loan that out to somebody else. In fact, if you look in the textbooks, there's a little footnote saying, sorry, we had to do a little math here. And they tell you how to sum an infinite series.

Ira Glass

Jacob says that he just figured our money works this way because we're a complicated, industrial society with banks and stock markets and financial instruments of all kinds. And then he read something that made him realize that no, no, no. The fictional quality of money is inherent in the very idea of money. In any system of currency, no matter how simple, this aha moment came to him when he was reading this book from 1910 about an island called Yap in the South Pacific. At the time on this island, for currency, this pre-industrial people used something completely impractical and counter-intuitive, these massive stone sculptures in the shape of coins. And I mean massive.

Jacob Goldstein

They're huge. The biggest ones are taller than a man. You know, they weigh more than a car. And they use them for big things, right? They wouldn't use them for little everyday purchases. You'd use it for a dowry or like this anthropologist told me if somebody from your village got killed in another village and you wanted to get his body back, like a warrior, you might use one of these stones to pay the other village to get your warrior's body back.

So there's this obvious problem. There's no machinery. These things weigh thousands of pounds. They have essentially an innovation. It's really a financial innovation, which is you don't have to actually have the stone to own the stone. The stone, like you know, it's sitting on a path or something and everybody just knows that I own it one day. And then you, you Ira, you kill the warrior from my village and I'm like OK. I want to pay you with this stone and you give me back my warrior. I get the warrior back, the stone doesn't have to move. It just sits there on that path, but now everybody knows that's Ira's stone. I don't own it any more.

Ira Glass

But Jacob says it gets even more interesting. To understand this next point you have to know first that the limestone that they use to make these giant sculpture coins, it wasn't actually found on Yap. They had to go to another island 250 miles away to make them.

Jacob Goldstein

And these guys are going out in these little bamboo boats to some other island where they're carving these giant limestone disks. At one point, a crew had gone and cut one of these giant stones on this island and they were bringing it back across the sea. And just before they got back to Yap, there was some kind of storm, and so they had to cut the store loss or the stone went overboard or something. In any case, the stone ended up on the bottom of the sea. The crew themselves survived. They made it back to the island and they told everybody what had happened. And the people of Yap said, that's fine. That's no problem. We believe you and this stone money, this giant stone on the bottom of the sea, it exists. It's still good money. Somebody owns that stone, even though it's sitting on the bottom of the ocean.

Ira Glass

What?

Jacob Goldstein

But it makes sense, right? One reaction is like, oh my God, these people are crazy. But it's like a logical extension of what they're already doing.

Ira Glass

In fact, Jacob says it's not logically different from what we do. For money after all, long ago, we used to use gold. And if you wanted to buy something you'd have to carry around these heavy, shiny pieces of metal. And then we decided, no, let's just leave the gold in a bank. Instead of the gold what we're going to carry around are these pieces of paper. And the paper on them says, yes, there's gold. You can take this paper money to a bank. You can swap it for gold. Maybe you've seen old dollars that say on them promise to pay the bearer so many dollars in gold. You could swap it.

Then we decided, it was the year 1933. We decided you can't trade in dollar bills from gold anymore in this country. Dollar bills are just going to represent the idea of money. That's it. Not gold. They're just money.

And when I talked about this with Jacob he said, it gets even more abstract.

Jacob Goldstein

Because now, if you think of most of the money that you have, or most of the money that I have, it's never currency. I get paid. That is just a direct deposit from NPR, from my employer, to my checking account. It's not like they give me a bunch of hundred dollar bills every week. And then, I pay my bills online. So currency even now is like old-fashioned. You don't have to touch money. You don't have to see it. It's just information.

Ira Glass

Until this conversation it never occurred to me that money doesn't change hands when we pay our bills online or anything. Like I don't know why I never even stopped to think, right, at no point does the bank go and deliver like $100 to the phone company on my behalf. It really is just numbers going back and forth in the computer.

Jacob Goldstein

Yeah. Nothing happens in the physical world. I mean I guess, except electrical pulses I guess it would be flying back and forth between computers. The money doesn't really exist. Not only is there no gold. There aren't even bills for most of the money that exists. Most of the money that exists is just the idea. It's just the bank saying, yes, there is this much money in your account.

Ira Glass

Well today on our program, the most stoner question we have ever posed on our show, what is money? That's right. What is money? That's the question we're asking. I know how it sounds. The fact that the money that we use every day is about as real as those stones at the bottom of the sea, that makes our lives easier in all kinds of ways, but it is also incredibly dangerous that that is the nature of money as you'll hear today in two action-filled acts.

When you understand the money is created out of nothing, you understand all kinds of things. Stay with us.

Act One. The Lie That Saved Brazil.

Ira Glass

Act 1: The lie that saved Brazil.

Well let's begin with a trip to a country where the fiction that is money. That fiction, that set of shared beliefs that is a fiction completely fell apart. Everyone stopped believing in their currency and of course, that had disastrous results.

The same country in a truly incredible piece of policy making, you almost never hear of any government anywhere solving a problem so thoroughly and so well. The government tricked a hundred fifty million people into believing again, that their money was worth something when there was absolutely no evidence to support that claim. And it worked. Here's Chana Joffe-Walt.

Chana Joffe

When you know the story I'm about to tell you, it really makes every single mundane commercial experience in Brazil seem like a complete miracle. Car commercials, miracle. The mall is a miracle. The guy in a bright red t-shirt in the mall who shoves paperwork into my hands and offers me a credit card, miracle. The credit card is a brand new concept in Brazil. And actually, everything that happens in this mall is new. The way everyone spends money in the mall is new. You can walk away with new shoes or a new backpack today and pay for it later.

[SPEAKING PORTUGUESE]

Translator

So a soccer ball in two installments.

[SPEAKING PORTUGUESE]

Translator

Any shoes, the average is six installments.

[SPEAKING PORTUGUESE]

Translator

So a backpack, six installments.

[SPEAKING PORTUGUESE]

Translator

All products.

Chana Joffe

Everything?

Translator

Yeah.

Chana Joffe

As I said that-- everything-- I was holding up a pair of sunglasses off of his display. "Yes," he told me, "six payments. Take them home today. Pay in six monthly installments later."

In the past, you never would have had this, because Brazil had incredibly high inflation. In 1990, inflation in Brazil was 80% a month. Not a year, a month. So think about those sunglasses.

Say they're selling for $10. One month later, with 80% inflation, the price is $18. Six months later the sunglasses are $340. And by the end of the year, that price tag reads more than $10,000. Brazilians lived with high inflation like this for decades. They could not figure out how to fix it. And they might still be living with it if it weren't for some unlikely heroes. Actually, the most unlikely group of national heroes you can imagine. Four former drinking buddies from grad school with a crazy plan, who were suddenly put in charge of the country's biggest economic crisis ever.

But before we meet them and hear their story, let's talk about the way it used to be. So remember, prices were going up every day. Think about what that actually means in the supermarket. They had to change the prices every day. Ketano Ferare, this flirtatious 75-year-old in Sao Paulo remembers that that was someone's job. To walk the aisles and change the prices.

Ketano Ferare

There was a guy who changed the sticker. Plop, plop, plop, plop, plop. You passed the guy. And you buy things.

Chana Joffe

Wait, you would walk by the guy? You would like get in front of him?

Ketano Ferare

You run.

Chana Joffe

In front of him?

Ketano Ferare

In front of the guy and buy things like that.

Chana Joffe

So that you could get to the goods before he changed the price?

Ketano Ferare

Yes, like that.

Maria

And the whole day this machine is doing this.

Chana Joffe

This is Maria Leopoldina Biarenbeck. Someone with a very Brazilian long name, who spent a lot of time in supermarkets during this period. Maria was a housewife with four kids. She wasn't the running type. She would politely ask the sticker man to stop and wait. And if he didn't, she had another trick. She'd pull off his new sticker, walk up to the register, and pay the old price.

Maria

But then they discovered the maquinilla the small machine. And that you couldn't do anything because it printed the price. That wasn't easy to take off.

Chana Joffe

Brazil's problem with inflation started all the way back in the 1950s. The president wanted to build a massive city in the middle of the jungle, a new capital, Brasilia. It would cost a lot of money and the government didn't have the money to do it, so it did what governments often do when they have a dream they can't afford. They essentially, printed the money, created it. Now the problem with doing this of course is inflation.

If there's say, a hundred dollars in the economy, you create a hundred more, now every dollar is worth half as much. That's inflation. And in Brazil, inflation continued for the next five decades. Year after year, Brazilian money was worth less and less. And this causes all sorts of problems, not just with the sticker man.

Say you get a $1,000 bonus at work. You put that money in a drawer. A year later it's worth a fraction of what it was. The minute you get paid the clock is ticking on your money. I talked to one man who used to have nightmares about money sitting on top of his dresser. Sitting still, just losing value.

A beer manufacturer told me he just stopped making beer because making beer just takes too long. You'd buy all the wheat and the hops and by the time it was brewed, everything was worth so much less.

By the late '80s, inflation was the number one political issue. And so began the plan to fix it.

Now it turns out one of the best people to talk to about this is Maria Leopoldina Biarenbeck, the housewife who peeled off the stickers. Maria can take you through a detailed history of each president's failed plan to stop inflation. But you have to ask Maria every question twice because the first time she always answers like this.

Maria

I don't know because I never had to do anything. I was just a plain housewife and mother.

Chana Joffe

And then proceeds to be the most knowledgeable person you will speak to on the topic. OK, so first up she says, President Sarney in 1985. His solution? Simple. Businesses are raising prices, make that illegal. There was a price freeze. The problem with that was no one wanted to sell anything at the frozen price. All the merchants were just waiting for the day when prices would eventually go up again.

Maria

And you know what happened. People hid the merchandise. And you couldn't buy anything because they wanted the prices to grow up because the situation was a fantasy. It was not real. You couldn't find meat at the butcher's.

Chana Joffe

They just weren't buying meat to sell?

Maria

They hid the cattle.

Chana Joffe

So they hid the cattle waiting for the price freeze to go away?

Maria

Yes.

Chana Joffe

Really?

Maria

Yes. You can do that here, it's a very large country.

Chana Joffe

So that failed. And then came President Collor in 1990. He had a plan to solve inflation, but there was one catch. You're not going to be able to take your money out of the bank for a while.

Now Maria is telling me this and my translator, Flavio Ferreira, who is sitting in on our conversation could no longer keep quiet. He remembers that moment when the minister of finance made the announcement.

Flavio

And I remember the day when she was on TV explaining that they were going to confiscate everybody's money. So next day's banks would not work. I remember the face of that woman. She had studied in the best schools and she had been a professor at [INAUDIBLE]. And she was explaining to the nation as an economist why we need this. To end inflation we need the country to be together with us. But I remember I'm looking at her and said, God, a government cannot do that. I mean when a government does that, you lose people's respect.

Maria

Oh, it was terrible. It was terrible. So many people committed suicide.

Chana Joffe

When you mess with people's money, it doesn't go well. The economy went off a cliff. President Collor was impeached. And there was a new president and a new finance minister, and inflation kept rising. The Brazilian economy was at a low point. It looked like there was nothing to be done to fix it. Enter our heroes, those four economists we talked about at the beginning, who basically enter the picture now because the new finance minister knew nothing about economics. Which is why, on March 27 of 1993, he called one of our heroes, Edmar Bacha.

Edmar Basha

I was in my office at that university here, at the Catholic university. And I got the call soon after I had finished teaching a class. And he said, well, I've just been named the finance minister. You know that I don't know economics. So please come to meet me in Brazil tomorrow. We need you. Well, I was terrified.

Chana Joffe

Basha had been waiting for three decades for this call. Ever since he ad his three friends taught graduate school together at the prestigious Catholic university in Rio. Four friends who had been studying Brazilian inflation for a decade. Four buddies at the campus bar complaining to each other about how this government didn't know what it was doing and that government didn't know what it was doing. Four buddies who were now being asked by the government to come and fix thing their way, the plan they'd spent years on. And so, of course, their first answer, no. We don't want to. Here's another one of the four, Andre Lara.

Andre Lara

This is a process. It's something that requires many years. It's not something that we can do. It's not magic. It's not a trick that we do overnight.

Chana Joffe

When I asked Lara, wasn't it exciting though? He looked confused for a moment. And then scornful. People, he told me, should be interested in ideas, not feelings. They thought we had a trick. There is no trick. There is only long, hard, complex multi-step macroeconomic plans designed specifically for the Brazilian context.

Basha is the more casual of this pair. Yeah, he tells me, we had a trick. But I was busy and I didn't want to move to Brasilia. The government did not give up. Lara and Basha were taken to dinner with members of parliament who told them how much the country needed them. They got calls at home, senators told them, you will have free reign. Whatever you think is best. Basha was invited to meet the president.

Edmar Basha

And then I ask an autograph for my kids and then he wrote a note, a note addressed to my two kids in saying, "Please tell your father to work fast for the benefit of the country."

Chana Joffe

That's what he wrote in the autograph?

Edmar Basha

Yes. I still have that note.

Chana Joffe

So there was a lot of pressure?

Edmar Basha

Oh yes. Yes. It's one thing to do it at your office. It is another thing to put the thing together. It had never, never been put in practice anywhere this way.

Chana Joffe

Eventually the four signed on and presented their plan. And basically what they said was, you have to hit the underlying causes of inflation. You have to stop the printing presses, stop creating money so quickly. But you also have to stabilize people faith in money. And this is where their plan was different.

They didn't want to just change the underlying causes of inflation. They wanted to change people themselves. People where the problem. People had to be tricked into thinking money had value, when all signs told them that was absolutely not true. So Basha says, they wrote a plan for a new currency, one that was stable, dependable, trustworthy. The only catch was this currency would not be real. It would not be printed. There would never be coins. It was fake. They called it a virtual currency.

Edmar Basha

We called the unit of real value, URV. Yeah, it was a virtue that didn't exist in fact.

Chana Joffe

People would still have cruzeiros, the local currency in their pockets. But when they got paid, their wages would be listed in URVs. Taxes were in URVs and all prices were listed in URVs. And URVs were stable. And so, for example, when you went to the store and bought some milk.

Edmar Basha

How much does it cost? Say well, know we have it cost X. Let's say one URV. Well, how much is that because I cannot pay with URV. Well, I have this little table here and today's value of URV in cruzeiros is seven cruzeiros per URV. So it cost one URV, seven cruzeiros.

You go next week, well, it's still one URV. But then you say, how many cruzeiros? You look, well, 14.

Chana Joffe

Every night the central bank would put out a memo with the official conversion rate. And a table would get printed in the newspaper. The store clerk could look at the table in the newspaper and see, Monday, one URV is equal to seven cruzeiros. Tuesday, 12 cruzeiros. Wednesday, 14. Milk or whatever it was you were buying would stay the same price. There was no need for the sticker man.

And the idea was you would start thinking in URVs. Because just last week you got paid a thousand URVs. Milk costs one URV. Next month, you'd get a thousand URVs again and milk would still be one URV. The exchange into cruzeiros, what you actually handed the clerk would change. But the price in URVs would not. So that was the plan and Basha presented it to the senator from Sao Paulo.

Edmar Basha

And then when I explained to him the plan, after a while he said, well-- with some anguish in his voice said, well Basha, if this is the only way that you tell me that it can be done, then we will follow you to the precipice.

Chana Joffe

And so the four economists went about explaining to the country that everyone should now talk in a virtual currency.

Maria

We didn't understand it what it was. We asked, how much is that? Oh, it's so may URVs. I used to say it was a fantasy because it was not real.

Chana Joffe

Still, people used it without being forced to. One store would be selling milk for one URV and eventually, all the stores would be. People would know, that's an appropriate price for milk. Which I can tell because I get paid a thousand URVs. Inflation began to go down. 80% a month to 50%. It even got close to 40%.

Edmar Basha

And then when we are satisfied that prices are relatively in good synchrony we declare well, from this day, the virtual currency becomes a real currency. The cruzeiro real is going to disappear and everyone is going to receive from now on its wages and pay for all the prices in the new currency, which is the real. Which is equal to one URV. And also, equals to $1. And that is the trick.

Chana Joffe

It wasn't the only trick. While they put the URVs in place, the group of four also made the government balance its budget and slow down on the money creation. And then, one day, July 1, 1994, the central bank deployed truckloads of new cash in this new currency, the real, to banks in the cities, to the provinces, and waited on the ready for the four economists to say go.

Edmar Basha

And I remember the day that we launched and the real, I have this journalist who had become a friend of mine. And then she came to me and said, Professor, do you swear that inflation's going to end tomorrow. I said, yes, I swear that's going to end tomorrow.

Maria

Everybody was very happy.

Chana Joffe

Everyone in Brazil, collectively, as a country, tricked themselves into believing that this fake currency was real. More real than the actual physical bill they were holding in their hands. And that made all the difference. That made it real. For money, it's crazy but that's all you need. People to believe in it. Our four heroes literally turned Brazil's economy in the opposite direction with their plan. Brazil went from being an irrelevant, economic basket-case to one of the most important economies out there. The eighth largest in the world.

Cardoso, the finance minister who hired our four heroes after admitting he knew nothing about economics, was elected president. Twice. And the four economists, despite the fact that most people don't know them by name, really are seen as heroes. These guys made money worth something. Almost everyone I talk to about what happened in 1994 when they got the real described it as magic. Which you'd think the four would like, but Lara does not appreciate decades of research being referred to as magic.

Andre Lara

There's nothing magical in URV. It's very technical and very-- But basically it was just we established the idea of a unit of account that gives you the sense of value, relative value.

Chana Joffe

Basha, on the other hand, doesn't mind it so much.

Edmar Basha

It's very funny because people today, you go around and people think that this is so natural to live in a country without inflation.

Chana Joffe

It's so natural that now, when you walk into a store in Brazil, instead of a sticker man raising the prices, you can walk out of that sort with your sunglasses in hand and not finish paying for them until six months later. In just 20 years, Brazilians have gone from an absolute faith that their currency has no value to an absolute faith that its value will never change.

Ira Glass

Chana Joffe-Walt. Coming up, we go to a place where no journalist has been, this room inside the Federal Reserve that is like financial a black hole where the normal rules of money do not apply. That's in a minute. Chicago Public Radio and Public Radio International when our program continues.

Act Two. Weekend At Bernanke's.

Ira Glass

This American Life. I'm Ira Glass. Each week on our show of course, we choose a theme, bring you different kinds of stories on that theme. Today's show, "The Invention of Money." We have stories today about the fictional quality of money. How it gets made out of nothing, and what's great about that, and all the trouble that can get us into.

We've arrived at Act 2 of our show. Act 2: Weekend at Bernanke's.

When the United States was on a real gold standard, it was clear what money was and how much money there was. Each dollar corresponded to a dollar of gold that in a vault somewhere. But when we went off the gold standard, somebody had to decide how much money there would be. Some entity had to be entrusted with that power. In our country and just about every modern country today, we give that power to something called a central bank. Our central bank is named the Federal Reserve. You've heard that name, probably. And like all central banks, it has one magical power. The Federal Reserve can create money any time it wants. It's the one institution in America that can decide, OK, the economy would run better, interest rates would drop, whatever, if there was more money out there. Or it can decide there should be less money. It controls the amount of money in our economy, including in a very literal way.

If you have any cash in your pocket right now, pull it out, you see the name right at the top of the bills, Federal Reserve note. They're the ones who call up the Bureau of Engraving and Printing and say, print some more of the stuff. And here's where things get tricky.

Though the Federal Reserve does that, and though the Federal Reserve's chairman is appointed by the president. And though the Federal Reserve is subject to congressional oversight, and though the Federal Reserve's name includes the word, "federal," it is not actually part the federal government. It's an independent institution. And you may remember presidents like Nixon wanting the Fed to do this or that and the Fed chairman basically telling them to go take a hike. They're supposed to do what they think is best for the economy, not what's best for the president's political future.

With me so far?

Since 2008 when the current financial crisis took hold, the Fed has done all kinds of things that central banks just don't do. Stuff the Fed has never done. Stuff that would have been unthinkable in the past. It's all happening on a scale that is bigger than anything the Fed has ever tried in its history. Basically, the Fed has gone to central bank crazytown. And the danger, if the Fed screws up is that the fiction that we call the US dollar loses value. The people stop believing in it. Alex Blumberg and David Kestenbaum are to explain to us now two things, what the Fed usually does and what it's done since 2008 that seems so extreme.

Alex Blumberg

Up until recently when the Federal Reserve did this dangerous and magical thing of creating money out of nothing, conjuring money out of the void, it happened in a kind of solemn ritual.

David Kestenbaum

The ritual goes like this, every six weeks in an ornate conference room inside the Federal Reserve building in Washington, DC, there's a meeting.

Alex Blumberg

The meeting is closed to the press, members of Congress, even the president isn't allowed. The meeting is run by the chairman of the Fed, currently Ben Bernanke. You've heard his name in the news a lot. It is a meeting of the Federal Reserve's Open Market Committee.

Gerald O'driscoll

Even though major things, major policy issues are being decided, it's not an exciting experience.

Alex Blumberg

This is Gerald O'Driscoll, Jr. who attended a couple of these meetings back in the 1990s when he was vice president of the Dallas Regional Federal Reserve.

David Kestenbaum

So at these meetings, all these Federal Reserve officials get up and make presentations about the economy. What are the bright spots? what are the weak spots? Are things getting better, worse, staying about the same? And then, they take a vote to decide the big question. Should there be more or less money in the US economy?

Alex Blumberg

Now this question has huge ramifications. More money generally means it's easier for businesses and everyday people to get loans, which means it's easier for businesses to expand or new businesses to start up. Which ultimately translates into more jobs and a better economy.

David Kestenbaum

But, more money can also mean inflation. Which if it gets out of control, can really cripple the economy. Just ask the people of Brazil.

Alex Blumberg

So it is a balancing act, with the fate of the US economy hinging on the Fed's decision. Not that anyone there acts that way. Again, Gerald O'Driscoll.

Gerald O'driscoll

It's almost ceremonial. There's an order in which the staff reports take place. The questioning is kind of orchestrated.

Alex Blumberg

They're only like, we're pulling the levers of the largest economy in the history of mankind.

Gerald O'driscoll

Yeah. You almost forget that that's what's happening until they start to read the policy directive, which is exactly what they're going to do. Then you remind yourself what all this has been about.

Alex Blumberg

I sort of think of it like a joystick. You move it too far in one direction, you get out of control inflation. You move it too far in the other direction and then you can really sort of put the brakes on the economy. Is that too simplistic a way of thinking about it or is that?

Gerald O'driscoll

I mean it's OK to think about it that way. I winced a little when you said that because the joystick presumes a very precise control, which is exactly what they don't have.

Alex Blumberg

Right.

Gerald O'driscoll

It's more like you're moving a super tanker and you start moving the wheel and there's no effect that you can see for quite a while.

David Kestenbaum

OK, so once they've decided to move the super tanker, how exactly do they create money out of nothing? Well the answer, the mechanics of how this works, are so weird and bizarre that when I first learned about it, I thought wait, that's what this all comes down to?

Alex Blumberg

They can't just create a whole bunch of money and then walk out to the street corner and start handing it out to people. That would be awkward for one, and it also would take too long. They need to get large amounts of money into the economy fast. And so they need someone who can handle a few billion dollars in one quick transaction, which means the banking system. Banks.

And how do they get money into the banks hands? They buy something from them.

David Kestenbaum

The most boring, safest, surest thing any bank owns, bonds issued by the US government. Treasury bonds. Big banks typically have billions of dollars in treasury bonds just sitting around on their books.

Alex Blumberg

And to buy these bonds, the Fed doesn't show up at the door with an armored car full of cash. Don't picture that. You need to picture a computer screen at the Fed that shows the amount of money in a bank's account. Richard Dzina is a Senior Vice President of the New York Fed and he says, "someone at the Fed just changes that number. Adds a few billion, clicks a mouse--

Richard Dzina

And voila, money is created.

David Kestenbaum

Basically you press a button and in their account it says we have this much more money?

Richard Dzina

Yes.

David Kestenbaum

Does that seem weird to you at all after all these years?

Richard Dzina

Yes, it is still a magical process.

Alex Blumberg

All right, so the bank had a million dollars worth of bonds and now it has a million in cash. What's the big deal? A billion's a billion, right? But banks don't like to sit on lots of cash. They went to lend it out and earn interest on it. That's what banks do.

David Kestenbaum

So the banks start landing that money out. And that is how this new money enters into the economy. So if I'm a bank, before maybe I'd loan my money out at 6%. Now I got more money sitting around. I want to move it out the door fast, so I'll loan it out at a lower rate. Maybe 4%.

Alex Blumberg

And this is why you're always hearing on the news the Fed lowered interest rates or raised interest rates. They did that through this process we just described. Creating money out of nothing, buying or selling treasury bonds.

David Kestenbaum

OK, so that's what the Feds did for decades. The boring, sober, purchase or sale of boring, safe bonds. Now to Fe Crazytown.

Alex Blumberg

In the financial crisis. Starting in 2007, banks and firms up and down Wall Street were looking shaky. They had all these assets that were plunging in value and they needed someone to lend them money to offset their losses and stay afloat. And it was around this time that Jim Cramer freaked out on television.

Jim Cramer you may know, is the host of Mad Money on CNBC. And here is in August 2007, the very beginning of the subprime collapse talking about the Federal Reserve chairman Ben Bernanke. Actually, talking is probably the wrong word.

Jim Cramer

Bernanke is being an academic. He has no idea how bad it is out there. He has no idea! He has no idea!

Woman

Cramer.

Jim Cramer

I have talked to heads of almost every single one of these firms in the last 72 hours and he has no idea what it's like out there. None! My people have been in this game for 25 years and they are losing their jobs, and these firms are going to go out of business. And he's nuts!. They're nuts!. They know nothing!

Woman

Cramer.

Jim Cramer

This is a different kind of market and the Fed is asleep.

Alex Blumberg

So what Jim Cramer is saying in this very entertaining freak out is that the Fed should use its power to create money out of nothing in a way that we haven't talked about yet. In addition to the ceremony meetings the Fed has every six weeks about the money supply, it also has these special emergency powers that it's only supposed to use in situations where the banking system is on the verge of collapse. And Cramer here is asking the Fed to use those powers to become what's called, "the lender of last resort."

Specifically, he said this.

Jim Cramer

Listen, open the darn Fed window.

David Kestenbaum

The darn Fed window.

The Fed window is jargon for the Fed creating a bunch of money out of nothing and lending it to institutions in crisis who can't borrow money through the normal private market. Sort of like a bank window where you could walk up and get an emergency loan from a magical genie.

Alex Blumberg

This was a revolutionary proposal on several levels. A lot of these financial institutions that needed help were not traditional banks. And the Fed hadn't lent emergency money to something other than a boring, highly regulated bank for over half a century. But seven months after Cramer's tirade, though certainly not because of it, the Fed did just what he was suggesting.

Reporter

A dramatic story has broken this morning to the effect that JP Morgan and the New York Fed are combining to in essence, bail out Bear Stearns.

David Kestenbaum

As the financial crisis unfolded, the Fed created over one trillion dollars. Which it lent out as emergency loans to all the big names on Wall Street: Goldman Sachs, Morgan Stanley, huge banks like City Group and Bank of America. The Fed lent money to private equity firms, hedge funds, and even regular companies like Verizon, GE, and Harley Davidson.

Alex Blumberg

And it wasn't just the recipients of that cash that were new, it was also what the Fed was requiring in return, the collateral.

In the past, in the rare instances that the Fed used its powers to serve as the lender of last resort, it demanded the highest quality collateral in return. Assets that were safe and would hold their value.

David Kestenbaum

In other words, the Fed treated banks in financial trouble the same way a hard-nosed pawn broker treats people in financial trouble. It would hold onto your grandmother's antique earrings and in return, give you far less than they're worth. And if you bring in cheap plastic earrings, the Fed wouldn't give you any money at all.

Alex Blumberg

But in 2008, the Fed started accepting all sorts of cheap, plastic jewelry. Collateral that just months ago it never would have touched.

David Kestenbaum

For example, at one point in the crisis, the Fed acquired $75 billion worth of toxic assets from Bear Stearns and AIG. Our colleague Chana Joffe-Walt talked to Vincent Reinhart, another former Fed official now at the American Enterprise Institute about just how disturbingly unboring these assets were. There were mortgages on resort hotels.

Vincent Reinhart

It's a grab bag. There's a lot of Hilton properties.

Chana Joffe

The Hilton Hawaiian Village, the Hilton of Puerto Rico.

Vincent Reinhart

Yeah. The Maldives by the way.

Chana Joffe

The Maldives are on here, yeah.

Vincent Reinhart

The Fed has a claim on a hotel in Jacksonville, Florida.

Chana Joffe

So there's a mall in this portfolio that I believe has gone into bankruptcy.

Vincent Reinhart

What's the name of it?

Chana Joffe

Crossroads.

Vincent Reinhart

Crossroads? Crossroads Mall in Oklahoma actually, isn't it? Oh, yeah, it owns it. REO means real estate owned.

Chana Joffe

So the Fed owns that mall? So the Fed is now in the commercial shopping business?

Vincent Reinhart

Yeah. It's mind-bending, isn't it?

Chana Joffe

It is a little mind-bending.

Vincent Reinhart

So actually, you should have the image of chairman Ben Bernanke flying to a speaking engagement and he could look out the window and look down and say, boy, I own a piece of that. I own a piece of that. I own a piece of that. And that's the way the Fed's balance sheet is right now.

Alex Blumberg

And it didn't stop there.

In late 2008, the economy was still in trouble, so the Fed launched another program. Which would become by far, the biggest single purchase they'd ever made. They would be creating more money than ever before.

David Kestenbaum

But what were they going to buy with that money to get the money out into the economy? Well, what is there out there that adds up to hundreds of billions of dollars? Home mortgages. The Fed would buy home mortgages. Not the sub prime ones that got into trouble. This was not a plan to rid the banks of bad assets. They would be buying safe, high quality mortgages. But they would be buying a lot of them. In the form of mortgage backed securities. The hope was this would inject a lot of new money into the economy and prop us the housing market.

Alex Blumberg

But how many to buy, that was the question. Vincent Reinhart, the former Fed official, says that the Fed had no idea how many mortgages it would need to purchase to do all this. How much money should it create?

Vincent Reinhart

They were working in the dark. Economic theory doesn't tell you how many securities you have to buy to have a predictable effect on interest rates or activity. So they went and they picked a round number. A big, round number.

Alex Blumberg

Do you imagine them actually sitting around saying, I don't know, a hundred billion, two hundred, a trillion? 700? How about 5?

Vincent Reinhart

I can imagine them sitting around in that big room around a big table arguing in terms of probably quarters of trillions. How about 250? No, how about 500?

Alex Blumberg

In the end, the number they settled on was massive, one and a quarter trillion dollars.

David Kestenbaum

Just a reminder, a trillion dollars is to a million dollars what a million dollars is to $1.

For some reason that's hard for me to explain. I wanted to see the room where this happened, where the money gets made. It seemed like a long shot, the Fed is historically very media shy. It doesn't grant on the record interviews, much less tours. But this time the Fed said OK. And so one morning, Chana Joffe-Walt and I found ourselves at the southern tip of Manhattan, outside the Federal Reserve Bank of New York. It's a big, imposing building. The iron work, the marble in the lobby all say, I'm a big, imposing building. I am the central bank of the biggest economy in the history of the world. They've still got a bunch of gold in the basement. And by bunch, I mean possibly the largest collection of gold anywhere.

And then, our guide, Nate Wuerffel, took us up to the room.

Nate Wuerffel

So this is the mortgage backed security purchase program team room. It's a small-ish room. It's not as big as you might think when you consider the size of the overall purchase program.

David Kestenbaum

Whatever you imagine the room looks like where you can create one and a quarter trillion dollars, this is not it. It is not grand. It is not ornate. It is not ceremonial. It has four grey cubicles, it has computer screens, and there's no other way to say this: it's a mess. There are papers and notes scattered around. There is a yoga ball someone has been sitting on. And there is a basketball net, possibly Nerf brand. This is where the magic happens.

Julie Remache and her colleagues spent weeks and weeks and weeks in this room, buying and buying and buying.

Julie Remache

This program was big. It represents 20% of the outstanding agency mortgage backed securities in the market. So it's big.

David Kestenbaum

You bought a fifth of what was out there?

Julie Remache

That's right.

David Kestenbaum

Can I ask a kind of weird question, but I know it's one everyone's going to ask. Where does the money come from?

Nate Wuerffel

It's created. So that's the nature of central banking. So central banks, when we actually purchase a security, we pay for it with cash that is basically created by the central bank. That's the nature of central banking around the world.

Alex Blumberg

The sheer amount of new money that the Fed created was unprecedented. From the time we went off the gold standard of 1933 until 2008, the Fed had created a net total of $800 billion. In the months after the financial crisis, that number nearly tripled to almost $2.4 trillion.

Julie and her colleagues were spending more newly created money in just 15 months than the Fed had created in its entire history up until 2008.

Ira Glass

Hey fellas.

Alex Blumberg

Hey Ira.

David Kestenbaum

Hey, what are you doing here, we're doing a radio story.

Ira Glass

Well I know. Actually, I've been listening and it's fascinating of course. And excellent story as always. But I have some questions. For starters, you're saying that the Fed created over a trillion dollars to bailout the economy. Does that money get added to the deficit?

Alex Blumberg

No, it doesn't.

Ira Glass

Why not?

David Kestenbaum

The federal deficit, that's when the federal government spends more money than it collects in taxes. So it has to borrow to cover the difference. That's with the deficit is, that borrowing. And the Fed is, as you said in your intro, a totally separate institution. It's not part of the federal government. So it hasn't nothing to do with this.

Ira Glass

OK, but when the Fed loses money on some mall that it now owns, does that eventually in some sneaky back door way, come out of my taxes?

David Kestenbaum

No. Because first of all, it's not part of the government. Second of all, even if it were, every year the Fed makes a profit. The Fed never loses money. It can create money out of thin air from nowhere. It uses that to buy government bonds, things that pay interest. So it gets interest every year. And every year it makes a huge profit, like in 2009 at the height of the crisis, it made $47 billion.

Alex Blumberg

And that profit they always turn over to the federal government. So it actually reduces the deficit.

Ira Glass

And so all of this money that they've created since 2008, totaling it up if I understand right, it's over $1.6 trillion. Does this have anything to do with the TARP program to buy up toxic assets?

David Kestenbaum

No, that was the federal government.

Ira Glass

Does it have anything to do with Obama's stimulus package.

David Kestenbaum

No, federal government.

Ira Glass

But this $1.6 trillion is bigger than both of those combined. We have these huge fights that drag on for weeks over the stimulus package and over these other things, and then the Fed does something that dwarfs these in size. It's twice as big as either of those programs. And there's no discussion. The Congress doesn't debate it. The president doesn't approve it. There's no public input. Some eggheads in a room just kind of wave a wand and then it just happens?

David Kestenbaum

Yep. That's the idea of a central bank.

Ira Glass

OK, is that a good thing?

Alex Blumberg

It depends who you talk to. Most economists would say, thank God the Fed did this. Thank God the Fed used its super power to create money out of thin air and lent that money to Harley Davidson and Goldman Sachs, and you and me to buy houses, and Bear Stearns in exchange for that mall in Oklahoma. Doing all that crazy crap, that kept us out of soup lines.

David Kestenbaum

And the Chairman of the Federal Reserve, Ben Bernanke, says that because of the Fed's actions, quote, "The world was spared a cataclysm that could have rivaled or surpassed the Great Depression." And Bernanke is actually one of the leading scholars on the economics of the Great Depression. And he says, in fact, that the Great Depression happened in large part because the Fed back then wasn't crazy enough. Or as he put it, they were quote, "Insufficiently willing to challenge the orthodoxies of their day."

Alan Blinder is in this camp. He's an economist at Princeton and the former Vice Chairman of the Fed. And he says he's glad Bernanke was willing to challenge the orthodoxy of our day. To take the Fed to Crazytown.

Alan Blinder

But that is a very good thing that that happened. These very, very unusual things that the Fed did are things that are either never going to be repeated again in your lifetime, or if they are, it'll probably be a long time from now. Once we get back to normal, this is not going to be part of the Fed's everyday way of doing business. It will go back to the boring thing of creating or destroying money by buying or selling treasury bills.

David Kestenbaum

There's a bunch of people who disagree with Alan Blinder on this though, and we're going to be hearing a lot from them in the coming months. Maybe you've followed some of the news about how three quarters of the House of Representatives-- democrats and republicans alike-- voted for more scrutiny of the Fed. That happened because of this guy.

Chairman

Gentleman, Texas Mr. Paul for three minutes.

Ron Paul

Thank you, Mr. Chairman. I want to thank you for calling this hearing.

Alex Blumberg

Ron Paul, the libertarian-leaning republican congressmen from Texas is the go-to guy in Congress if you're looking for someone to criticize the Federal Reserve.

Ron Paul

The question we in the Congress have to ask is, why is it that the Congress is so eager to give up their prerogatives and their responsibilities? Whether it's giving the executive branch the authority to go to war without the Congress saying much, or whether it's turning over the monetary system to somebody that can operate essentially in secrecy and deal not with a few hundred billion dollars like $800 billion here and there, but trillions of dollars when it adds up.

Alex Blumberg

For decades, Paul has been on the campaign to abolish the Federal Reserve. And it was lonely campaign. But with the republicans taking over the House of Representatives, Ron Paul, author of a book called End the Fed is now the head of the committee, which oversees the Fed.

David Kestenbaum

And the main beef that he and lots of people have with the Fed is that it's unclear the Fed really knows what it's doing. US economy they say is too big and too complex to be managed by a group of PhDs who meet every six weeks, no matter how smart they are. By trying to manage something that can't be managed, the Fed does more damage to the economy than good.

One of the leading critics of the Fed, an economist named George Selgin says the Fed is like a fireman who gets credit for putting out fires that he helped start.

Alex Blumberg

And Selgin has a point. Take our current recession. Even if you grant that the Fed helped get us out of it, most economists and not just Fed critics say that it was Fed actions earlier in the decade, holding interest rates too low for too long, which helped create the housing bubble, which got us into this mess in the first place.

David Kestenbaum

So today, the Fed is in uncharted territory. Instead of making little movements to the super tanker's steering wheel, the Fed has spun it, leaving us all with two questions. What direction us the tanker going to go as a result? And do we trust the person at the helm?

Alex Blumberg

The Fed has created a huge, unprecedented amount of money, thrown it into the economy. Now they have to figure out how to get it out before it causes inflation. The Fed has gone a little crazy. Once you go crazy, how do you get back to being boring?

David Kestenbaum

And trustworthy? Remember the value of our money depends on that trust. Again, Vincent Reinhart talking to our colleague Chana Joffe-Walt.

Vincent Reinhart

Because you trust the Fed and because you know everybody else trusts the Fed, it is valued in markets because other people value it.

Chana Joffe

So really, that's the biggest thing that the Fed has going for it. It's not the gold in the basement, it's not the marble floors. The most important thing to them is just that everyone trusts them.

Vincent Reinhart

The magic of central banking is it works on trust.

Alex Blumberg

Once that trust is gone, the value of money goes away too. It becomes just another stone on the bottom of the ocean.

David Kestenbaum

The Fed knows this of course. That the weirder they act, the more they throw the whole enterprise into question. And this explains one of the biggest mysteries of all about visiting the Fed, why everyone is so, so boring. Their public pronouncements are famous for bureaucratic inscrutability. And I mean, here they are creating trillions of dollars out of thin air, doing things that in the history of central banking have never been done before. And in all our dealings with them, they are-- and you'll have to trust us on this, we'll spare you the tape-- studiously going out of their way to be as unexciting as possible.

Alex Blumberg

Case in point, remember the mortgaged back security program? One and a quarter trillion dollars. That number was essentially pulled out of thin air. And yet, once the Fed officials in charge of purchasing those securities were given the number--

Dave Kestenbaum

They hit it exactly. Well, almost.

Male Speaker 3

I think we fell short by like--

Vincent Reinhart

$0.61 short. $0.61.

Chana Joffe

What?

Vincent Reinhart

Seriously.

Chana Joffe

No way. $1.25 trillion, you got within how much?

Vincent Reinhart

We got very, very close to the actual $1.25 trillion. I do think we were within pennies of the final charge. We didn't want to go over $1.25 trillion because $1.25 trillion was our mandate. We don't want to ever go beyond our mandate. And so if we erred, we wanted to err on the shy side.

David Kestenbaum

Whether you like it or not, this is our system. Empower a secret society of PhD with the ability to create trillions of dollars out of nothing and hope we can trust them to get it right and stay as boring as humanly possible.

Ira Glass

Alex Blumberg and David Kestenbaum. They're both part of our Planet Money team, along with Chana Joffe-Walt and all the other reporters you've heard this hour. Their free podcast and their blog explain the stuff that all of us have never understood more entertainingly than seems fair. You can find all that at NPR .org/money.

[MUSIC - "WE DO (THE STONECUTTERS' SONG)" BY THE SIMPSONS]

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This American Life is distributed by Public Radio International. WBEZ management oversight for our show by our boss, Mr. Torey Malatia, who can get, I have to say, pretty irate when I don't dress warmly enough for the snow storms we've been getting lately. I overheard him in the hallway yesterday when I didn't bring a scarf.

Man

He has no idea how bad it is out there. He has no idea! He has no idea! None!

Ira Glass

I'm Ira Glass. Back next week with more stories of This American Life.

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