Understanding Government Debt: The Treasury's Indispensable Role

"Our nation's wealth is being drained drop by drop because our government continues to mount record deficits. The security of our country depends on the fiscal integrity of our government, and we're throwing it away." (Senator Warren Rudman).

Warnings like this are commonplace today. The assumption is that the Federal government has limited financial resources and at some point will be unable to service its growing debt; in short, that it will become bankrupt. Responsible fiscal policy is viewed as requiring a balanced budget. Individuals and firms can indeed borrow their way into bankruptcy. There is no such danger for the government when it borrows in the same currency that it creates. In a fiat money system, the government has just as much money at its disposal under a budget deficit as with a budget surplus.

When we adopted a monetary base of intrinsically worthless paper money in the mid-20th century, we created a new paradigm that is still widely misunderstood. The imperatives are quite different from those of the earlier gold-based system. The key to maintaining the purchasing power of money is to control the price of credit. That means controlling the cost to banks of acquiring the reserves they need to cover their depositors' transactions. The Fed has the primary responsibility, but the Treasury plays an indispensable role.

Government Money

We can think of "government money” as existing in two forms: the monetary base issued by the Fed, and securities issued by the Treasury. Base money represents immediate purchasing power, while Treasury securities represent future purchasing power. Treasury securities necessarily pay interest to compensate owners for the delay in purchasing power.

The private sector runs mainly on bank money created by banks when they lend to the public. Banks must hold enough reserves of base money to cover their depositors' transactions. The amount they must hold varies with the net amount of borrowing, which in turn depends on the interest rate. Since the Fed controls the interest rate, it is ultimately up to the Fed to limit the demand for bank money to what the public can absorb without undue inflationary pressure.

Treasury Operations

The Treasury deposits its receipts from taxes and the sale of its securities into accounts at commercial banks, known as Treasury Tax and Loan (TT&L) accounts. It spends out of its account at the Fed, and replenishes that account with transfers from its TT&L accounts. To minimize variations in aggregate reserves of commercial banks, the Treasury targets a constant balance in its Fed account. Thus for all practical purposes, the Treasury spends out of its commercial bank accounts.

If Treasury outflows consistently exceeded inflows, the money supply would steadily increase and create unacceptable inflationary pressures. Therefore the Treasury recaptures all of its spending on average. It does so with taxes and the net sale of securities when there is a shortfall in tax revenues. In effect the Treasury pays for its deficit spending by issuing securities rather than base money. That means deficit spending has no net effect on the immediate purchasing power of the private sector.

Tax or Borrow?

The choice between government taxing and borrowing, i.e. fiscal policy, is entirely at the discretion of Congress. That choice has economic consequences which can be either good or bad. Unfortunately fiscal policy is often governed by the belief that deficit spending is ipso facto bad. The real economic consequences are seldom considered in that decision.

Deficits represent no financial risk to either the government or the public. All too often the focus has been on irrelevant accounting issues. Indeed attempts to balance the budget can easily be counterproductive, especially during recessions. Conversely when the economy is sluggish or in recession, deficit spending helps support aggregate demand needed for recovery.

Rolling Over Government Debt

Nothing about government debt requires that it be paid off. Of course individual securities must be redeemed as they mature, but the Treasury can roll over its maturing debt indefinitely. Rolling over means selling new securities to pay for the redemption of maturing securities. This involves no new tax revenues.

Treasury securities offer a risk-free, interest-earning alternative to base money spent into circulation by the government. If the private sector has more non-interest-earning base money in the aggregate than it wishes to hold, its only alternative is to buy Treasury securities. Since the Treasury can pay whatever interest rate the market demands, there will always be willing buyers of its securities.

Net Financial Wealth of the Private Sector

Treasury securities are valuable assets for the holders. They can readily be sold for money or pledged as collateral for loans. Together with the monetary base created by the Fed, they comprise the net financial wealth of the private sector. By contrast, bank lending cannot change the net financial wealth of the private sector because bank credit is matched by an equal amount of borrower debt.

The value of Treasury securities to the private sector as a whole is in the principal, not in the interest payments they shed. The interest payments are matched by tax revenues, and are therefore a wash in the aggregate. Some fear that as the national debt grows it will create an ever increasing inflation rate. That fear is not supported by the historical record. The debt/GDP ratio reached an all-time high at the end of World War II, yet the inflation rate during the next two decades averaged only 2%. In the following decade the debt/GDP ratio fell to a long-term low, while the inflation rate averaged about 8%. If there is an upper limit to the debt in terms of its effect on the inflation rate, it has yet to be experienced.

Disclosure: Author in investing in various mutual funds, mainly at Vanguard.

Comments

[Steven Hansen:]

"Nothing about government debt requires that it be paid off. Of course individual securities must be redeemed as they mature, but the Treasury can roll over its maturing debt indefinitely. Rolling over means selling new securities to pay for the redemption of maturing securities. This involves no new tax revenues."

this is the way it is working but economically a larger and larger percentage of the budget is used to pay off debt. this system debases our currency.

2008 Dec 17 05:33 AM

[Moon Kil Woong:]

So far their inflationary regimes have failed as de-leveraging has made over $10 trillion disappeared. However, if they do overdo it the first thing you will see is no foreign appetite for US treasuries which will be a quick problem for their further inflating. If they do any more they basically are printing money without any regard to any sound economic policy.

The Fed asked to be allowed to buy any debt. If they can then since they are allowed to issue any money on any debt... ie US treasuries, they basically own the ability to make as much money as they want without any congressional mandate or approval or knowledge. Doing this basically could result in an Argentina like hyper-inflation where the Fed is Eva Perone.

Don't cry for me oh America... for I always loved the greenback.

2008 Dec 17 05:44 AM

[Alan von Al...:]

Anyone care to remember where the "greenback" came from? Gold clause contracts couldn't be paid off by the US Treasury, not even with wartime taxes, forefeitures, IOUs and requisitions. The Civil War greenback was no different than a worthless Continental dollar, until the Supreme Court held that greenbacks were legal tender for public debt (screwing the gold dollar lenders). FDR pulled the same trick in 1933, Nixon in 72.

I had a brief corrspendence with Milton Friedman in the late 1980s, when the Total US Debt (federal, state, local govt and private sector) as a percent of GDP exceed the high water mark of Worl War II. Friedman assured me that arithmetic ratios didn't matter, rather the rate of change on a log scale was the thing to watch. In the past six months, the rate of change has been flashing red. Cutting rates to zero and openly buying their own debt extinguishes whatever warning system we once had.

Mr Hummel was a career government worker. He's on the winning side, and proud of it, I suppose. NPR reported today that the only people now qualifying for home mortgages are teachers, cops and firefighters, the public servants who can't be fired, won't lose their jobs.

One last remark, for the record. It didn't have to be this way:

"The Fabians advanced the view [in 1889] that Socialism could be made to grow gradually out of existing institutions of society by a process of evolutionary development. Agreeing with Marx that the historical forces of economic growth were inevitably 'socializing' one part after another of the lives of men. they held that there was no need to overthrow the existing State, but only to capture it and transform it into an instrument of welfare." (G.D.H. Cole, British Working Class Politics, 1941)

It's change you actually *do* believe in.

2008 Dec 17 06:21 AM

[Alan von Al...:]

P.S. - This sucker is going down -- fast.
www.bloomberg.com/apps...

2008 Dec 17 09:02 AM

[puttster:]

Bad example saying the WWII debt did not lead to inflation. Inflation was Truman's biggest hurdle after the war. The tasks of restraining consumer spending while convincing labor and businesses to hold down wage and price increases became insurmountable for him. In 1945 and 1946 he tried to control the economy through price freezes. Despite those efforts, by August inflation was at 25% and the nation was near paralysis from a wave of strikes for higher wages.

I liked the article till I got to your statistician's trick of using a 20-year infalation average to make a point. Tricks like that impune the truth so now I don't know what to believe.

2008 Dec 17 09:40 AM

[bindlepete:]

Do some home work as to 1 who holds the government debt and 2 where we go is they stop buying outr paper. Argentina is a good case in point if you want to look at the real world and what can happen when the printing presses run well beyond productivity.

Further, see what we export relative to what we import. Cardboard, weapons, aircraft that arew subsidized by the taxpayer,unwanted and expensive services and some grain ( thank God) and few Yakima Apples.

If only we could find a market for our idiots.

Check out ShadowStats.com for a touch of reality and dump the " happy talk" in hopes that your distortions will keep the public quiet until you pass on. A strong dose of truth is now in order.

2008 Dec 17 11:42 AM

[Smarty_Pants:]

"In effect the Treasury pays for its deficit spending by issuing securities rather than base money. That means deficit spending has no net effect on the immediate purchasing power of the private sector."

Well, if you want to ignore the crowding out effect of selling Treasury debt then sure, no effect. In truth however, the private money that was used to purchase Treasury debt might have been spent or invested in a profitable enterprise instead of tied up in Treasury debt (so the gub'mint could waste the same amount on pork barrel spending).


"If the private sector has more non - interest - earning base money in the aggregate than it wishes to hold, its only alternative is to buy Treasury securities."

This is one of the most myopic statements on money I have ever read.

The *ONLY* alternative for extra money is to buy Treasury debt? Really?? What about corporate debt? Stocks or mutual funds? Commodities? Real estate? Foreign currencies or debt? Precious metals? Small businesses? Mattresses or cookie jars?

What the author claims to know about monetary theory is almost as scary as what he appears not to know, IMHO.

2008 Dec 17 11:46 AM

[William Hummel:]

The Fed has always been able to buy assets of any kind in whatever amount it chooses. As long as banks continue to hoard reserves rather than lending, the additional reserves created by the Fed's actions are non-inflationary. Indeed the current problem is getting out of a deflationary trap. When that problem is solved and bank credit begins to flow freely again, the Fed will recapture the excess reserves to drive the Fed funds rate up to a more normal range in order to prevent inflationary pressures.

Hyperinflation is entirely different from ordinary inflation. It occurs when the government is unable enforce tax collection or sell its bonds, and resorts to simply printing money to spend. That only happens when governmental authority collapses due to revolution, war, or gross corruption.



On Dec 17 05:44 AM constructe wrote:

>
> The Fed asked to be allowed to buy any debt. If they can then since
> they are allowed to issue any money on any debt... ie US treasuries,
> they basically own the ability to make as much money as they want
> without any congressional mandate or approval or knowledge. Doing
> this basically could result in an Argentina like hyper-inflation
> where the Fed is Eva Perone.
>
> Don't cry for me oh America... for I always loved the greenback.

2008 Dec 17 11:51 AM

[William Hummel:]

I was not a career government worker unless you count the millions of World War II draftees as career workers for the government. I worked for a private firm, whose customers included NASA and the Defense Dept


On Dec 17 06:21 AM Alan von Altendorf wrote:

> Mr Hummel was a career government worker. He's on the winning side,
> and proud of it, I suppose. NPR reported today that the only people
> now qualifying for home mortgages are teachers, cops and firefighters,
> the public servants who can't be fired, won't lose their jobs.

2008 Dec 17 11:56 AM

[Smarty_Pants:]

"When that problem is solved and bank credit begins to flow freely again, the Fed will recapture the excess reserves to drive the Fed funds rate up to a more normal range in order to prevent inflationary pressures." - Mr. Hummel


Let's see if I understand this statement in its entirety:

1) Economy is tanking
2) FED creates 'additional reserves' in the amount of several $Trillion to prevent said tanking.
3) Economy presumeably recovers
4) FED removes the several $Trillion of 'additional reserves' before they can cause inflationary pressures, without again causing the economy to tank.

I'll believe it when I see it.

At this point, step 3) is a debatable point though more of step 2) could be argued to rectify the defeciency. What gets me is the claim implied in step 4) where all that extra money is somehow removed without causing a reversion to step 1).


"Hyperinflation is entirely different from ordinary inflation. It occurs when the government is unable enforce tax collection or sell its bonds, and resorts to simply printing money to spend." - Mr. Hummel

That's where I see us heading. There's no way the gub'mint can tax enough out of the populace to pay off the existing debt, much less any additional debt the FED might conjur up so that leaves a constantly increasing stream of debt issuance to paper over the shortfall. Just who is going to buy that massive pile of debt forever?

Our foreign creditors will eventually realize that it isn't worth buying our debt any more when they see that we won't ever improve our deficit spending "habit". Not only that, but there's a real threat that some of them may even begin selling the debt they already own rather than buy more at negative real yields.

2008 Dec 17 12:16 PM

[William Hummel:]

No statisticians trick. The reason for the post war inflationary bulge had nothing to do with the large debt/GDP ratio that built up during the war. Rather it was due to the very high private savings during the war together with the lack of goods and services available immediately after. Rationing and price controls during the war left little for the public to buy until civilian production ramped up.

The peak post war annualized inflation rate was 19% in April 1947, and averaged 14.7% for the year. In 1948 it was down to 7.7%. Thereafter it was very low for about 20 years, except for a blip (7.9%) in 1951, probably due to the Korean War.


On Dec 17 09:40 AM puttster wrote:

> Bad example saying the WWII debt did not lead to inflation. Inflation
> was Truman's biggest hurdle after the war. The tasks of restraining
> consumer spending while convincing labor and businesses to hold down
> wage and price increases became insurmountable for him. In 1945 and
> 1946 he tried to control the economy through price freezes. Despite
> those efforts, by August inflation was at 25% and the nation was
> near paralysis from a wave of strikes for higher wages.
>
> I liked the article till I got to your statistician's trick of using
> a 20-year infalation average to make a point. Tricks like that impune
> the truth so now I don't know what to believe.

2008 Dec 17 12:26 PM

[William Hummel:]

There is no crowding out effect in buying Treasury securities. You are neglecting to account for the government deficit spending that caused the Treasury to sell its securities. The private sector still has the same amount of money to spend. There would be some temporary crowding out if the Treasury sold in too large an amount at one time because loanable funds might be depleted. But the Treasury borrows frequently in small amounts rather than in large chunks to avoid that squeeze on loanable funds.

If the public has more base money IN THE AGGREGATE than it wishes to hold, it cannot get rid of it by buying corporate debt, stocks, or any other non-government assets. Thus it's only interest earning alternative is to buy Treasury securities.


On Dec 17 11:46 AM Smarty_Pants wrote:

> "In effect the Treasury pays for its deficit spending by issuing
> securities rather than base money. That means deficit spending has
> no net effect on the immediate purchasing power of the private sector."

>
>
> Well, if you want to ignore the crowding out effect of selling Treasury
> debt then sure, no effect. In truth however, the private money that
> was used to purchase Treasury debt might have been spent or invested
> in a profitable enterprise instead of tied up in Treasury debt (so
> the gub'mint could waste the same amount on pork barrel spending).

>
>
>
> "If the private sector has more non - interest - earning base money
> in the aggregate than it wishes to hold, its only alternative is
> to buy Treasury securities."
>
> This is one of the most myopic statements on money I have ever read.

>
>
> The *ONLY* alternative for extra money is to buy Treasury debt?
> Really?? What about corporate debt? Stocks or mutual funds? Commodities?
> Real estate? Foreign currencies or debt? Precious metals? Small
> businesses? Mattresses or cookie jars?
>
> What the author claims to know about monetary theory is almost as
> scary as what he appears not to know, IMHO.

2008 Dec 17 01:16 PM

[moonbat1775:]

This came to me on a Sunday walk

ForwaRd and Backward;
booms and busts.
The poor are oppressed
for the sake of fear/lust.

ForwaRd and Backward;
is there no other way?
It turns out there is
(and the looters shall pay) .

ForwaRd and Backward;
you soon must die.
Your crimes stink to Heaven
and hence a Reply.

2008 Dec 17 02:30 PM

[moonbat1775:]

dedicated to those vexed by unrighteousness.


Concerning the fiat masters and their friends

They now are the insiders
but soon they'll be looking in
to a system they're too poor for
and even Gold will turn on them.
Gold has an honest daughter
and also brilliant, you will see.
And she'll pick her friends most carefully,
for the rest, obscurity.

Let the cynical disbelieve, they will serve their purpose too.

2008 Dec 17 02:33 PM

[moonbat1775:]

" Thus it's only interest earning alternative is to buy Treasury securities." The Author to Smarty

Yep, roped by a government-backed money and banking cartel (GBMBC) into buying government debt. How convenient!

2008 Dec 17 02:58 PM

[Smarty_Pants:]

"There is no crowding out effect in buying Treasury securities. You are neglecting to account for the government deficit spending that caused the Treasury to sell its securities" - Mr. Hummel

And you are assuming without question that the spending done by the gub'mint would be anywhere near as productive as an equivalent amount of spending done by the public. That is a claim to which I heartily disagree.

How many billions has the gub'mint spent on studies to figure out why people smile, or other such nonsense? If that money had instead been spent by citizens on any market provided product or service at least it would be supporting an activity that was actually desired instead of one that some bureaucrat thought was useful.


"If the public has more base money IN THE AGGREGATE than it wishes to hold, it cannot get rid of it by buying corporate debt, stocks, or any other non-government assets." - Mr Hummel

I'm afraid you've lost me there. Your statement makes no sense to me whatsoever.

It appears to me you are stating that, somehow, magically, all the base money that "isn't needed" (whatever that means) is always returned to purchase Treasury debt. You will need to further define your terms because it seems you intend them to mean other than their usual and accepted definitions.

It seems to me that if I have more money than I wish to hold I can use it for a great many things other than to buy Treasury debt. I can only imagine that you mean something other than 'income in excess of my expenditures' when you speak of "more base money ... than [I] wish to hold".

To me these refer to the same thing. Money I have earned that I don't have to spend on necessities. What mechanism is there that forces me to put that money into Treasury debt?

You also write as though all the "excess base money" (in the aggregate) is somehow moved as a single block, as though one party is deciding where it must go, instead of millions of individuals making independent decisions on where they will each put their excess earnings.

Once that 'excess base money' is in circulation SOMEBODY must own it and be able to decide what to do with it. It certainly can't be one entity, and they all presumably have free reign to do with it as they wish. What economic law forces them to return it to Treasury debt?

2008 Dec 17 03:10 PM

[Smarty_Pants:]

On Dec 17 02:58 PM moonbat1775 wrote:

> " Thus it's only interest earning alternative is to buy Treasury
> securities." The Author to Smarty
>
> Yep, roped by a government-backed money and banking cartel (GBMBC)
> into buying government debt. How convenient!

Yep. As The Mighty Mogambo (TMM) would say:

"We're freakin' doomed!"

MB, I hope you have recovered from whatever loco inducing substance got you going on my 1000 comment. I had absolutely no idea what you were ramblin' on about. There is nothing to forgive.

2008 Dec 17 03:18 PM

[moonbat1775:]

"MB, I hope you have recovered from whatever loco inducing substance got you going on my 1000 comment. I had absolutely no idea what you were ramblin' on about. There is nothing to forgive. " Smarty

You're the best and perceptive too. And along those lines:

Jars of clay
can carry the truth.
And sometimes maybe,
even cracked-pots
but sometimes sadly
it seems they cannot.

I'm sorry I rained on your 1000 comment parade. Your rash friend will be more careful in the future. May the Boss make it up to you.

mb

2008 Dec 17 04:05 PM

[moonbat1775:]

Smarty,
Cracked-pot or no, i can do some math and here are some results of growth rates for the banking and money model I've been working on:

growth rate = average productivity growth per savings (P) * ratio of savings to total money supply (SR) * 2

Average productivity growth per savings (P) = 5%
ratio of savings (SR) = 1/5
growth rate = 2% per year This matches the US historical average. Money doubles in value in 35 years for a 20% savings rate. This will be the steady state model after the Monies have prevailed over fiat.

100% savings model (theoretical maximum growth rate)
Average productivity growth per savings(P) = 5%
ratio of savings (SR) = 1.0
growth rate = 10.0% Money doubles in value every 7.5 years assuming new savers/savings replace lent out Money. This is the model that will consume fiat for good.

For any interested: The New Money Model

2008 Dec 17 05:15 PM

[Alan von Al...:]

Ahem. "Private" firms who exist solely and exclusively as contractors to DoD and NASA are government agencies, period. It's folly to pretend that mercenaries like Blackwater guarding State Dept officials in Iraq aren't really soldiers, or that KBR drivers and quartermasters aren't really working for the US Army.

The proper guage of public employment-benefit is simple. Government expenditure (fed + state + local) as a percent of GDP equals total drag on the economy. When it tiptoes over 50% the game is up.

Your remarks about "excess" money that private investors merrily hand back to the Treasury are amusing or horrible, depending on one's capacity for gallows humour. Commercial paper, IPOs, LCs are dead, munis unsaleable, Tier 3 buried in mystery, piling up on the Fed's fantasy balance sheet, and gold headed for the moon.

2008 Dec 17 05:17 PM

[moonbat1775:]

Here that link to "The New Money Model" (recently revised):

members.cox.net/moonba...

2008 Dec 17 05:20 PM

[William Hummel:]

My comment in quotes says nothing about individual choices and actions. That's why I emphasized IN THE AGGREGATE, which I thought would make it clear.

Individuals will of course buy or sell according to their needs or wishes. However if there is more base money in the system than meets their needs or wishes AS A WHOLE, the only way the excess can be eliminated and earn a return is when some buy Treasury securities. If they continue to buy and sell financial instruments created in the private sector, that will simply move money around without eliminating excess.


On Dec 17 03:10 PM Smarty_Pants wrote:

> "If the public has more base money IN THE AGGREGATE than it wishes
> to hold, it cannot get rid of it by buying corporate debt, stocks,
> or any other non-government assets." - Mr Hummel
>
> I'm afraid you've lost me there. Your statement makes no sense to
> me whatsoever.
>
> It appears to me you are stating that, somehow, magically, all the
> base money that "isn't needed" (whatever that means) is always returned
> to purchase Treasury debt. You will need to further define your
> terms because it seems you intend them to mean other than their usual
> and accepted definitions.
>
> It seems to me that if I have more money than I wish to hold I can
> use it for a great many things other than to buy Treasury debt.
> I can only imagine that you mean something other than 'income in
> excess of my expenditures' when you speak of "more base money ...
> than [I] wish to hold".
>
> To me these refer to the same thing. Money I have earned that I
> don't have to spend on necessities. What mechanism is there that
> forces me to put that money into Treasury debt?
>
> You also write as though all the "excess base money" (in the aggregate)
> is somehow moved as a single block, as though one party is deciding
> where it must go, instead of millions of individuals making independent
> decisions on where they will each put their excess earnings.
>
> Once that 'excess base money' is in circulation SOMEBODY must own
> it and be able to decide what to do with it. It certainly can't
> be one entity, and they all presumably have free reign to do with
> it as they wish. What economic law forces them to return it to Treasury
> debt?

2008 Dec 17 05:37 PM

[Socialism c...:]

And...you see any of those to be unlikely...why???

On Dec 17 11:51 AM William Hummel wrote:

>That only
> happens when governmental authority collapses due to revolution,
> war, or gross corruption.
>

2008 Dec 17 06:50 PM

[Socialism c...:]

"Nothing about government debt requires that it be paid off. Of course individual securities must be redeemed as they mature, but the Treasury can roll over its maturing debt indefinitely."

Um...wrong. That's the definition of "pyramid scheme". Fails when the creditors wanna cash out...OR...when they refuse to continue buying in.

2008 Dec 17 06:52 PM

[Alan von Al...:]

Psst, S.C.C -- Of course Mr. Hummel is right, govt never has to pay off its debt, they can do whatever they please. Confiscation, conscription, wage and price controls, rationing, prohibition, forfeiture, nationalization, wars of choice, wars by proxy, bank holidays, parades, fireside chats.

2008 Dec 17 08:06 PM

[Alan von Al...:]

Vital role of the Treasury?? Destroyer of value...

Dec. 15 (Bloomberg) - The world economy has “suffered a cardiac arrest”... The U.S. stock market has plummeted, wiping out $7.6 trillion of investor wealth... Other markets have also fared badly, with the MSCI World Index of stocks in 23 developed countries down 47 percent... "We’re facing a once-in-a-century problem,” says Harvard University professor and former IMF chief economist Kenneth Rogoff. “The global scale and magnitude of it is much greater than those we’ve seen before. We’re going to face a deep downturn... The challenge now is to contain it to a couple of years and not a decade.”

Dec. 15 (Bloomberg) - Manufacturing in New York contracted in December at the fastest pace on record as orders and shipments remained weak. The Federal Reserve Bank of New York’s general economic index fell to minus 25.8, the lowest level since records began in 2001, from minus 25.4 in November, the bank said today. Factories are scaling back production as consumers retrench in the face of a weaker job market and a recession that began a year ago. A deepening global credit crisis has hit overseas trading partners, undermining foreign demand for U.S. goods.

2008 Dec 17 08:52 PM

[Smarty_Pants:]

"However if there is more base money in the system than meets their needs or wishes AS A WHOLE, the only way the excess can be eliminated and earn a return is when some buy Treasury securities. If they continue to buy and sell financial instruments created in the private sector, that will simply move money around without eliminating excess." - Mr. Hummel


But if they 'continue to buy and sell financial instruments ... without eliminating excess' doesn't that imply inflationary pressures will result?

Take a look at the FED's long term graph of base money:

research.stlouisfed.or...

Two items of note:

1) The few instances of 'removing' base money from the economy are dwarfed by the overall growth of same. The instances which are noticable are tiny in comparison to the general trend of the chart.
2) Approximately 40% of the cumulative growth in base money over a period of 95 years has occurred in the past 3 months.

Taking those two items together, it would seem to me that the odds of removing the "excess" recently added to our money supply are very slim indeed. In fact, it would be the great exception to the rule.

While your original statement may hold in theory it doesn't necessarily equate to it actually happening. There is a difference between what might happen ('excess money being removed') and what does happen (base money growing over time and very rarely being removed).

I MIGHT win the lottery next month, but that doesn't mean I should go out and buy a $1,000,000 home tomorrow.

Until such time as the base money supply actually DOES begin to recede it would be prudent to plan for future inflationary pressures, especially given the immense growth of base money in the very recent past.

2008 Dec 18 09:50 AM

[moonbat1775:]

""However if there is more base money in the system than meets their needs or wishes AS A WHOLE, the only way the excess can be eliminated and earn a return is when some buy Treasury securities. " the author via Smarty

The key question is "buy Treasuries from WHOM"? If from the Fed, then the money is sterilized since what does the counterfeiter-in-chief need with money? But if from the Treasury then it goes to the government which will just spend it.

2008 Dec 18 10:35 AM

[William Hummel:]

If there is more base money outstanding than is desired, that implies the private sector as a whole is ignoring the returns they could get by buying Treasuries with the excess. Remember that base money (except for billfold cash) is not a part of the money supply. It exists only as bank reserves. And if banks are not lending against those reserves, there is no inflationary problem.

The inflationary potential is there if the credit money supply begins to expand out of proportion to available goods and services. Of course the Fed recognizes this and will start selling its huge portfolio of recently acquired assets to drain the excess reserves as needed to restore the Fed funds rate to a non-inflationary level.


On Dec 18 09:50 AM Smarty_Pants wrote:

> "However if there is more base money in the system than meets their
> needs or wishes AS A WHOLE, the only way the excess can be eliminated
> and earn a return is when some buy Treasury securities. If they continue
> to buy and sell financial instruments created in the private sector,
> that will simply move money around without eliminating excess." -
> Mr. Hummel
>
>
> But if they 'continue to buy and sell financial instruments ... without
> eliminating excess' doesn't that imply inflationary pressures will
> result?

2008 Dec 18 12:35 PM

[William Hummel:]

The excess base money can be recaptured either by the Fed selling securities from its own portfolio, or by the Treasury net selling its securities.

Treasury spending is not a function of its bank balances. It only acts as the government's fiscal agent by making payments and collecting the funds needed to make those payments, through taxes and if necessary the sale of its securities.

The Treasury doesn't know or care what the motives are for those who buy its securities. It simply keeps inflows balanced against outflows so its commercial bank balances remain roughly constant at a level sufficient to cover its near term payment obligations.




On Dec 18 10:35 AM moonbat1775 wrote:

> ""However if there is more base money in the system than meets their
> needs or wishes AS A WHOLE, the only way the excess can be eliminated
> and earn a return is when some buy Treasury securities. " the author
> via Smarty
>
> The key question is "buy Treasuries from WHOM"? If from the Fed,
> then the money is sterilized since what does the counterfeiter-in-chief
> need with money? But if from the Treasury then it goes to the government
> which will just spend it.

2008 Dec 18 12:50 PM

[Smarty_Pants:]

"base money (except for billfold cash) is not a part of the money supply. It exists only as bank reserves. And if banks are not lending against those reserves, there is no inflationary problem." - Mr. Hummel


Apparently there is cause to believe that this is not the case. A recent report published by Celent regarding the implementation of the credit crisis response has come to the conclusion that lending is occuring a levels higher than before the bailout was undertaken.

"1) Overall lending by US banks is at a record high and has increased during the credit crisis.
2) Interbank lending is at record highs and has increased during the credit crisis.
3) Consumer credit is at record highs and has increased during the credit crisis.
4) Commercial paper markets are operating within their historical norms.
5) Lending by banks to businesses is at record highs and has been growing rapidly.
6) Municipal bond markets are operating within their historical norms.
7) Deposits at banks have shown a substantial increase since the start of the credit crisis."
8) Commercial bank lending has increased 15% since Fannie/Freddie were nationalized.

Source:

www.celent.com/PressRe...


Sure looks like inflationary tendencies are what to expect at this point in time.

2008 Dec 18 05:05 PM

[William Hummel:]

Celent claims that "Interbank lending is at record highs and has increased during the credit crisis." However its own graph shows that total bank credit outstanding was higher in October than November.

The Fed's website at www.federalreserve.gov... shows it dropped by 50 billion in November. It also shows that total bank credit grew by 4.7%from April thru November 08 compared to 8.9% for the same period in 07.

The annualized growth rate for the three-year period ending June 2007 when the sub-prime mortgage fiasco began to hit the financial markets was 9.4%. That's twice the growth rate during the last 8 months, a huge difference.

On Dec 18 05:05 PM Smarty_Pants wrote:

> "base money (except for billfold cash) is not a part of the money
> supply. It exists only as bank reserves. And if banks are not lending
> against those reserves, there is no inflationary problem." - Mr.
> Hummel
>
>
> Apparently there is cause to believe that this is not the case.
> A recent report published by Celent regarding the implementation
> of the credit crisis response has come to the conclusion that lending
> is occuring a levels higher than before the bailout was undertaken.

>
>
> "1) Overall lending by US banks is at a record high and has increased
> during the credit crisis.
> 2) Interbank lending is at record highs and has increased during
> the credit crisis.
> 3) Consumer credit is at record highs and has increased during the
> credit crisis.
> 4) Commercial paper markets are operating within their historical
> norms.
> 5) Lending by banks to businesses is at record highs and has been
> growing rapidly.
> 6) Municipal bond markets are operating within their historical norms.
>
> 7) Deposits at banks have shown a substantial increase since the
> start of the credit crisis."
> 8) Commercial bank lending has increased 15% since Fannie/Freddie
> were nationalized.
>
> Source:
>
> www.celent.com/PressRe...

>
>
>
> Sure looks like inflationary tendencies are what to expect at this
> point in time.

2008 Dec 18 08:38 PM

[Smarty_Pants:]

"The Fed's website at federalreserve.gov... shows it dropped by 50 billion in November." - Mr. Hummel

Data taken from Mr. Hummel's FED link and also from FED monetary base data:

Date ......... credit .... monetary base
08/2008 ... 9415.2 ....... 871.333
09/2008 ... 9575.2 ....... 936.176
10/2008 ... 9957.1 ..... 1142.254
11/2008 ... 9897.9 ..... 1480.845

(my apologies if the colums don't align very well, I tried)

Granted, total bank credit was ~$50 billion lower in November than in October, but it was also ~$320 billion higher in November than in September and ~$485 billion higher in November than in August. Bank credit is higher now than when the FED began dumping base money into the system back in August.

It doesn't look like a contraction in bank credit to me, just the opposite. One small decline in a single month does not a contraction make when the trend is showing the opposite.


"The Fed's website ... also shows that total bank credit grew by 4.7%from April thru November 08 compared to 8.9% for the same period in 07. The annualized growth rate for the three-year period ending June 2007 when the sub-prime mortgage fiasco began to hit the financial markets was 9.4%. That's twice the growth rate during the last 8 months, a huge difference." - Mr. Hummel


Come, come now. As a retired engineer with a background in missile flight control you should know better than to claim that slower growth is equivalent to a reduction. Reductions require a negative sign, not a smaller plus sign.

Say your car is speeding toward a cliff at 100 mph and you take your foot off the gas during the last 50 feet. Do you feel better knowing that the car is only going 30 mph when it goes over the cliff? Just because you are no longer speeding along as fast, you are still moving forward and will eventually reach the precipice.

Bank credit is expanding while base money is exploding. The facts are there in black and white and supplied by the FED banks themselves.

According to your own theory, we should be preparing for further inflation until such time that we see significant reversals in those trends, such as bank credit back below 9500 billion or the monetary base back below 900 billion, where they were before the credit crisis began.

While those levels may yet come to pass, I for one will not be holding my breath waiting.

2008 Dec 19 11:45 AM

[Smarty_Pants:]

One further point:

"The Fed's website ... also shows that total bank credit grew by 4.7%from April thru November 08" - Mr Hummel.


Yet the data above shows that bank credit increased 5.1% from August to November of 2008. It seems that the rate of increase is growing since the crisis began, though the small amount may be statistical noise.

2008 Dec 19 12:24 PM

[moonbat1775:]

I must add some corrections to a scheme for equity backed monies before I retire to lick my wounds. Turns out I neglected that bank reserves must absorb 1/2 of growth
to keep pace with the growth in money backing to maintain the 100% reserve requirement. This might limit growth in the money value to 1/2 of what I previously stated.

My apologies for my "irrational exuberance".
The idea has promise nonetheless. Time will tell.


Corrected calculations for an equity backed money and banking model:

money appreciation rate = average productivity growth per savings per year (P) * ratio of savings to total money supply (SR)

Average productivity growth per savings (P) = 5%
ratio of savings (SR) = 1/5
growth rate = 1% per year This is 1/2 the US historical average. Money doubles in value in 70 years for a 20% savings rate. This seems slow but it is a conservative figure.

100% savings model (theoretical maximum growth rate)
Average productivity growth per savings(P) = 5%
ratio of savings (SR) = 1.0
growth rate = 5.0% Money doubles in value every 15 years assuming new savers/savings replace lent out Money.

Jars of clay
can carry the truth
and sometimes, maybe,
even cracked-pots;
but sometimes sadly,
it seems they cannot.

mb

2008 Dec 19 03:12 PM