In the course of a post at Benzinga.com, A Modest Proposal for Ending Debt Limit Gridlock: Feed the Children, Don't Eat Them, Prof. Randy Wray explains how the federal government creates money by crediting bank accounts as an introduction to his proposal for both simplifying the process and also resolving the dilemma of the debt limit. This is an excellent summary of the money creation process. I'm clipping it out and saving it for future reference.
The dilemma arises when the Congress appropriates funds for various projects and then finds that it has created a situation that prevents the US Treasury from issuing the funds to pay for what it has appropriated by exceeding the debt limit that it has set one itself. This is a self-created obstacle that serves no useful purpose, since the funds have already been approved by Congress and the president in previous appropriations bills. The debt limit doesn't prohibit new spending as much as it creates a situation in which the government cannot meet existing commitments and obligations. Prof. Wray shows how this situation arises by explaining how the federal government creates its funding through currency and securities issuance, and he puts forward a proposal showing how the process can be streamlined to resolve the dilemma.
"Here is the modest proposal. When Uncle Sam needs to spend and finds his cupboard bare, he can replenish his demand deposit at the Fed by issuing a nonmarketable, nonbond, nontreasury warrant to be held by the Fed as an asset. With the full faith and credit of Uncle Sam standing behind it, the warrant is a risk-free asset to balance the Fed's accounts. If desired, Congress can mandate a low, fixed interest rate to be earned by the Fed on its holdings of these warrants (to be deducted against the excess profits it normally turns over to the Treasury at the end of each year). In return, the Fed would credit the Treasury's deposit account to enable government to spend. When the Treasury spends, its account is debited, and the private bank that receives a deposit would have its reserves at the Fed credited.
"So, from the Fed's perspective it ends up with the Treasury's warrant as an asset and bank reserves as its liability. The Treasury is able to spend as authorized by Congress, and its deficit is matched by warrants issued to the Fed. Congress would mandate that these warrants would be excluded from debt limits since they are nothing but a record of one branch of government (the Fed) owning claims on another branch (the Treasury). The Fed's asset is matched by the Treasury's warrant—so they net out. (The same can be said about Social Security Trust Fund holdings of nonmarketable treasuries, which also should be excluded from debt ceilings—a topic for another day.)"