Open Discussion on MMT

Post comments on any MMT related topic. Civil discussion and no coarse language.  Keep all discussions threaded (use the reply button on the comment you are replying to) where possible please.

I have left comments open as I’m afraid that if I now disallow comments we shall lose the existing comments.

Please head over to Open Discussion on MMT II.

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168 responses to “Open Discussion on MMT

  1. Macrocompassion

    The MMT seems to isolate money matters from the flow of goods, services, valuable legal documents etc., from macroeconomics. I don’t accept that this is possible, we need to consider the whole shebang together.
    Money seems to be made or issued by governments through their treasuries, to pass arround the social system and to finish up in the reserve deposits in banks after these banks have released deficit money which is not money at all. It is simply a temporary medium for commerce to take place and has no significant function without taking into account what it represents in terms of the above physical quantities of wealth and paper.

    • “The MMT seems to isolate money matters from the flow of goods, services, valuable legal documents etc., from macroeconomics.”

      Speaking as an MMTer that strikes me as complete nonsense. But if you want to get your point across, you’ll need to explain it in a lot more detail.

  2. Macrocompassion

    Ralph, you’r right about one thing, there is a need for detail in MMT. But the way to understand how macroeconomics works, including its money, is to look at it from a greater distance and to avoid the detail. We are on different wave-lengths here and the details associated with MMT distract one from the big picture of what is really going on. I have written plainly above, and even that you find to be unintelligable?

  3. “The MMT seems to isolate money matters from the flow of goods”

    Seems to? Seems more like you might be mistaken there! A key point that MMT economists always make is that the real economy consists of real resources with real people working to produce real goods and services.

    Therefore the idea that we can’t afford whatever the neoliberals claim cannot be afforded, is just a nonsense when large numbers of potential workers are unemployed or underemployed.

  4. I would like to find a use for MMT, but so far all it consists of is talk. If one of the MMT enthusiasts couls show us here where MMT leads and how it does so I would be grateful.

  5. When an economy reaches full employment and full production at stable prices and wages, respectively, it should adjust its spending so that the amount of money flowing into circulation equals the amount flowing out.

    I base this on a model of the economy using monetary flow analysis.

    The basic equation comes from hydrology, which is also about flows:

    IF – OF = ΔC

    Inflows minus outflows from circulation equal change in quantity of money in
    circulation.

    We can expand the above equation to break down the inflows and outflows into distinct flows:

    [E+G+I+L] – [M+T+S+P] = ΔC

    where
    E = exports
    G = government spending, both based on tax revenues and deficit spending
    I = Investment spending
    L = Bank loans (we shouldn’t ignore the role of banks in creating money)
    M = imports
    T = taxes
    S = savings
    P = pay back of bank loans
    C = quantity of money in circulation
    circulation is money involved in transfers between parties in the economy
    who are exchanging goods and services for money.

    There is a point in time where S = E+G+I+L at some previous point in time.
    Inflows circulate around and around between parties, each transaction involving exchange of money for goods and services, but possibily the one receiving the money may save some of it when he/she uses it to buy something else from someone, so eventually every party saves a bit until all of the money has been saved. This implies that there needs to be a continuous inflow of money into circulation to maintain the amount of money in circulation at a given level. (Think of swimming pools with inflows and outflows of water and the need to keep a certain level of water in the pool–just full but not overflowing.)

    The above equation is a simple differential equation. From it we
    can derive that the quantity of money in circulation C(i+1) equals
    the preceding quantity of money in circulation plus the change in quantity of money due to the net of inflows and outflows:
    C(i+1) = C(i) + ΔC(i+1) = C(i)+ IF(i+1) – OF(i+1)

    Thus if the change in quantity of money in circulation is positive, the quantity of money increases:

    C(i+1) = C(i) + ΔC(i+1)

    If the change in quantity of money is negative the quantity of money in circulation decreases:

    C(i+1) = C(i) – |ΔC(i+1)|

    So, suppose the economy is starting out and needing to grow, then
    we seek to make inflows greater than outflows, and do so until production and employment reaches a point where the quantity of money in circulation C’ is sufficient to clear the market of goods and services produced at full production with full employment.

    Any additional positive inflows at this point will make the quantity of money in circulation excessive, which will be inflationary (the water in the pool will be overflowing its banks). And the treatment for this is to reduce the inflows to less than the outflows until we get back to C’. That is, we need ΔC < 0. Inflows minus outflows is negative. When we get back to C' we should make ΔC = 0. We then have a balanced economy at full employment and production at stable prices and wages. We fight inflation by reducing inflows to less than outflows until we get back to full employment and production at stable prices and wages.

    A balanced economy is not a fiscal balance. Money is fungible. And while it is true that G – T = deficit spending, deficit spending need not be zero, as long as there are other outflows than T to counterbalance the deficit spending and other inflows at full production and employment etc..
    So, there are infinitely many compositions of IF and OF that would just cancel one another. Which means that we should not be focusing on balancing the budget with government spending just equal to tax revenues, but focusing on balancing the economy at full employment and production at stable prices and wages with an appropriate mix of inflows and outflows.

    We thus have a model of a fiat monetary system in which we can specify what produces inflation, how inflation should be fought, what is an ideal situation to reach and how to reach it from a deflated state. No longer must fiat money systems be regarded as necessarily inflationary, because we can show where we must stop growing the quantity of money in circulation to avoid inflation while having full production and employment.

    As for the question about what Australia must do if it has full employment, I think we need a bit more information. Do we have full production? If not, we can have more growth, and ΔC can be adjusted to be positive (usually by applying deficit spending or selling more exports, or getting more investment or bank lending). Do we have inflation or stable prices and wages? If inflation, we need to back off on the inflows of money into circulation. But there are many ways to accomplish this in terms of mixes of the various inflows and outflows.

    BTW, C' is not a fixed quantity. Population growth, changes in exports and imports, and investment and bank lending, etc. can change the quantity of C in circulation at which we optimally have everyone employed at full production at stable prices and wages. C is not a stable quantity. It must be constantly monitored and modified as needed to bring the economy to an optimal balance.

    Stanley Mulaik

  6. The concept of full production implies that all materials and means of manufacturing things from them are available and being used in the production of goods for sale. Full employment concerns all those willing and able to work attaining employment. So, MMT is not just based on money but on the use of money in exchanges of goods and services produced between parties in an economy. Money is essential to the exchange.
    Money is tokens in units of account of quantitative perceived value of goods and services between parties in the economy in the exchange of goods and services. There is no intrinsic and fixed standard of value; value has to be negotiated between parties. Every sale can be a bit different from every other, and may differ to some extent between parties, while there will be some approximate common agreement as to values for certain things which may serve approximately as standards of value.

  7. stanislaus2

    In describing my model above of monetary flows, I may have given the impression that at any time there may be for the policy maker any mix of values for money in each of the various flows. Actually, there are a few values which, say, Congress has to take as given and beyond its direct control. For example, Congress will have to accept the export/import difference as what it is. It may also have to accept the level of investment or saving as beyond its immediate control. Thus where it can have an immediate effect is on deficit spending as a way to bring inflows to a desired level against a portfolio of outflows. It can also reduce deficits, increase or decrease taxes, cut spending, both deficit-wise and tax supported.

    Deficit spending leads to new money creation and its spending into circulation in the economy.

    But in our system the actual creation of new money begins with banks endogenously responding to Treasury’s offering of securities to cover Congress’s deficit by lending Treasury money via the purchase of the securities. Congress may be the actual ultimate cause of the level of govt spending, but the banks’ ability to create new money out of thin air any time it lends, is a property of fiat money.

  8. In the US the settlement of transactions between the government and non-government is not in bank money but settlement balances (reserves) that are only issued by the Federal Reserve and exist only on the Fed spreadsheet. Purchasers of government securities have to settle in the government’s money and this is only obtainable through government spending in accordance with congressional appropriations or lending by the Fed.

    Banks can’t issue settlement balances or cash but rather have to obtain them from the government as sole provider of the currency. That is to say, banks are currency users and the US government is the monopoly issuer that acts through its agencies, the US Treasury and its bank, the Fed. Being the monopoly issuer, the government can set the own rate of the currency, which in the US is the Fed funds rate or “policy rate.” Both payment for newly issued government securities and payment of taxes is only accepted in government-issued settlement balances. Users of the currency, which includes banks, must obtain these in order to settle accounts with the government.

    Bank money is an IOU of banks that exists on the spreadsheets of the banking system as entries in deposit accounts. This is the money that the public uses supplement by the cash demanded at the window that banks supply from vault cash and obtain by exchanging settlement balances at the Fed.

    In the existing system government money sits at the apex of the hierarchy of money with bank credited money under it. This is called a fiat system because there is no convertibility to a real good at the apex of the system, e.g., a fixed amount of gold or silver. True fractional reserves systems are fixed rate convertible systems that create money as a token that is leveraged on real reserves rather than one to one, which would be a true full reserve system.

  9. Tom, I’m trying to see how what you say is compatible or incompatible with what I have written here above.
    When Congress says that the Treasury has to borrow money (from the banks) to get money for deficit spending, how is the bank money it lends to the Treasury US dollars, and how does the Fed enter into these transactions at this point, if it does at all?

  10. Tom, you wrote: “Banks can’t issue settlement balances or cash but rather have to obtain them from the government as sole provider of the currency. That is to say, banks are currency users and the US government is the monopoly issuer that acts through its agencies, the US Treasury and its bank, the Fed. Being the monopoly issuer, the government can set the own rate of the currency, which in the US is the Fed funds rate or “policy rate.” Both payment for newly issued government securities and payment of taxes is only accepted in government-issued settlement balances. Users of the currency, which includes banks, must obtain these in order to settle accounts with the government.”

    What connection does this have with the description of how the Treasury gets money from banks for deficit spending by issuing and selling securities to banks at public auction? Does the very act of a bank buying US T securities mean the bank must be buying with dollars? What makes that happen?

    I’m not clear on what is meant by ‘settlement balances’? I know that banks must get (buy or borrow) cash made at the mint via the Fed. Only when the money leaves the bank into circulation will it be in this form. Otherwise it is just reserve money exchanged between banks.

    Frank N. Newman says that the Treasury does not seek to pay back the principal on the securities it has sold to the banks when it seeks to deal with the demand for dollars at maturity. Treasury creates new securities with new future maturity dates and swaps them for the mature securities held by the banks. It also pays the interest on the mature securities at the swap. It also gets dollars for the interest payment from borrowing from banks with securities. The Treasury will do this rolling over of the debt each time the current securities mature, replacing the mature securities with new securities and adding in interest. So, the deficit spending debt’s principal never gets paid back to the banks, only interest is paid at each swap. But the Treasury has to borrow not only to get principal but interest, using securities.

    I can see how the very act of selling US securities means they must be bought with dollars. If the banks are creating the ‘dollars’ out of thin air as they do ordinarily in making loans (so they do not lend out deposits of other bank customers), then what makes them dollars? Does the act of buying US securities do this? Or does the act of first making a deposit for the loan out of thin air create a reserve account which must be in dollars and deposited at the Fed, and this Federal Reserve account is the source of the money transferred into a borrower’s account? When the customer takes the loan money from his account to buy something, at some bank place it will have to be in cash dollars, and some bank will have to convert the reserve dollars to cash, which comes via the Fed from the mint. But many exchanges can be done with reserve dollars alone.

    I’ll try not to ask too many questions at a time to avoid creating confusion.

  11. It looks like Tom you are talking about a process of dollar creation at the Federal Reserve that underlies all creation of money by US banks when they make loans. Unless you see this process, you will think the banks are creating dollars all by themselves. But only the Fed creates the dollars when the banks create reserve deposits in generating a loan. So, if a bank in generating a loan does not communicate its creation of the bank’s reserve deposit for the loan with the Fed and the Fed note it in its reserves, then the banks’ loan is not US dollars, and the Treasury could reject payment of taxes in those ‘dollars’??? Do I understand you correctly?

  12. Tom said: “True fractional reserves systems are fixed rate convertible systems that create money as a token that is leveraged on real reserves rather than one to one, which would be a true full reserve system.”

    Thinking of the gold keepers of old, by issuing certificates for claims on gold
    on the gold their customers had stored with the keepers, they were ‘leveraging’ these certificates on the gold of the depositors. That is a fractional reserve system. That is why gold-backed systems have to lend, so to speak, the deposits of the other bank customers, to have money that is lent gold backed and thus legitimate. If the borrower defaults, then the other depositors lose some of their deposits. If others want gold for their money, the bank has to have some deposits on hand to meet the demand.

    But then under a ‘full reserve system’ when someone presents money at the bank, the bank gives it an equal amount of money back in return. Dollar for dollar, pound for pound….

  13. “What connection does this have with the description of how the Treasury gets money from banks for deficit spending by issuing and selling securities to banks at public auction? Does the very act of a bank buying US T securities mean the bank must be buying with dollars? What makes that happen?”

    The auction is settled in settlement balances that are assets of bank and liabilities issued only by the central bank. The bank can only get those settlement balances from the central bank because that is the only place they come from and are actually entries on the central bank’s spreadsheet. Banks either get settlement balances directly from the central bank by borrowing or indirectly through the Treasury by its spending that credits banks’ settlement balance accounts with settlement balances.

    In the US, the auction of government securities is conducted by the Federal Reserve Bank of NY chiefly with the “primary dealers,” which are large banks. Those banks obtain settlement balances either in through deposits that transfer settlement balances to the bank’s account at the central bank, by borrowing in the interbank or money market, or by borrowing from the central bank using repo or at the discount window.

    Settlement balances get into the banking system chiefly through government spending and transfers that take place through the agency of the Treasury directing the central banks to credit accounts of recipients. The central bank then credits the account of a bank on its spreadsheet, and the bank then credits the customer’s deposit account as directed. The bank then has central bank liabilities as an asset and the credit to the customer’s deposit account as its own liabilities. This is net zero to the bank, a liability for the central bank and an asset for the bank customer.

    The liability being on the side of government and the asset being on the side of non-government, the net financial assets of non-government are increased. In the case of bank lending, the assets and liabilities created are in non-government, so they net to zero. Taxes withdraw net financial assets from non-government since an asset is deducted which extinguishes a government liability. Issuance of government securities and their auction into the private sector removes settlement balances and increases government securities, which are both liabilities of government and assets of non-government so the amount of net financial assets held by non-government remains unchanged.

    Banks can also access settlement balances either by borrowing by putting up collateral, chiefly Treasury securities. Banks automatically borrow at the discount window at the penalty rate if they are below the requirement at the end of a period.

    For example, when taxpayers needs to pay taxes, they may borrow from their bank to do get the funds to write a check against. This creates a loan and deposit, which constitute bank money. The taxpayer then sends a check to the Treasury in payment. The check is then settled in the payments system using settlement balances that the bank either holds in it account at the central bank or borrows from either another bank or the central bank. The central bank then credits the settlement balances to the Treasury account.

    As a matter of payments management, the check may not be immediately credited to the Treasury account at the central bank but may be held in a TTL account, which is a Treasury account at a bank rather than at the central bank. This is for the purpose of managing the amount of settlement balances in the payments system when the central bank is setting the policy rate above zero and not paying interest on settlement balances. So in that sense, bank money can be used temporarily to settle a tax liability for the taxpayer. The liability is then between the bank and the government and that liability is only settled in settlement balances at the central bank after netting by debiting the bank’s settlement balance account as a bank asset.

  14. I can see how the very act of selling US securities means they must be bought with dollars. If the banks are creating the ‘dollars’ out of thin air as they do ordinarily in making loans (so they do not lend out deposits of other bank customers), then what makes them dollars?

    What I am calling “settlement balances” are usually called “reserves” but that is not really correct since there are no actual reserves in floating rate non-convertible monetary system. “Reserves” is a holdover from the gold standard and it just confuses the issue by conflating two different monetary systems — fixed rate convertible and floating rate non-convertible.

    Settlement balances exist only on the spreadsheet of the central bank. They are denominated in the unit of account established by the government, in the US, the USD. Here is where it gets a bit confusing.

    “Currency” means “dollars” in the US. but “dollars” also signifies any type of money used in the financial system. This includes settlement balances at the central bank, bank IOUs in deposit accounts, and cash in circulation. However, the basic meaning of “dollar” in the US is the unit of account in whatever form. The same label doesn’t mean that all the forms are exactly the same in all respects however. Operationally, settlement balances, bank IOUs and cash in circulation are different even though they are all denominated in the dollar as the unit of account.

    Only settlement balances and cash are government liablities while bank IOUs are bank liabilities. Only cash is a token or “money thing.” The other forms are simply entries in accounting records.

    Banks are permitted to issue their own liabilities denominated in the unit of account, and they are granted access to the central bank to obtain settlement balances and cash. Banks can create their own liabilities out of thin air but not government liabilities. Only the government can do that through its agencies, the Treasury and central bank.

    This is a crucial distinction since it means that banks are actually users of the currency rather than creators of it. They can create liabilities denominated in the currency but they have to obtain currency that only comes from the government for final settlement after netting, as well as to meet demand for cash at the window. This requires that banks have access to the central bank and that the central bank act as the lender of last resort to ensure that all payments clear.

    Most settlement of accounts in non-government takes place through netting, either intra-bank in the case both parties use the same bank, or inter-bank in the cases that different banks are involved. However, final settlement after netting takes place in the payments system run by the central bank. Spot transactions are settled in cash. Transaction between government and non-government are also finally settled in the payments system or in cash at government payment offices.

  15. “It looks like Tom you are talking about a process of dollar creation at the Federal Reserve that underlies all creation of money by US banks when they make loans. Unless you see this process, you will think the banks are creating dollars all by themselves. But only the Fed creates the dollars when the banks create reserve deposits in generating a loan. So, if a bank in generating a loan does not communicate its creation of the bank’s reserve deposit for the loan with the Fed and the Fed note it in its reserves, then the banks’ loan is not US dollars, and the Treasury could reject payment of taxes in those ‘dollars’??? Do I understand you correctly?”

    When a bank creates a loan and a corresponding deposit, no “reserves” are simultaneously created. The loan (bank asset-customer liability) is “funded by” the deposit it creates (bank liability-customer asset). The “dollars” that are created by the loan as a deposit are bank liability that the bank promises to settle in cash or settlement balances as necessary. The bank has to obtain these since it cannot create them. It does this by borrowing from various sources of availability with the central bank always available as the lender of last resort to ensure that all payments clear.

    Since most settlement is by netting either intra- or inter-bank, cash and settlement balances are not needed to settle all transactions. In fact, netting us use to settle the majority of accounts. So settlement balances and cash are not needed for all transactions. IN the US most transactions take place in a dozen or so large banks and this is settlement mostly by netting. But final settlement takes place daily in the payments system in settlement balances.

    See CHIPS on netting
    http://www.newyorkfed.org/aboutthefed/fedpoint/fed36.html

    Final settlement after netting takes place in the government’s money, that is, government liabilities, either cash or settlement balances, both of which are only issued by the currency issuer as monopoly provider of the currency.

    See Fedwire
    https://www.frbservices.org/fedwire/

  16. “But then under a ‘full reserve system’ when someone presents money at the bank, the bank gives it an equal amount of money back in return. Dollar for dollar, pound for pound”

    What people mean by “full reserve” in a floating rate non-convertible system is that deposits are fully backed by settlement balances. This adds nothing to the existing system since the central banks stands ready as the lender of last resort to supply settlement balances as needed.

    Increasing the required reserves under the existing monetary system simply makes the cost of loans more expensive than it would be otherwise since banks have to borrow settlement balances, which involves payment of interest that gets passed on to the borrowers. Requiring more settlement balances means banks interest charges increase. Canada, for example, has no such requirement since ti is operationally unnecessary and is just an added cost of credit for no good reason.

    There is an advantage to a real reserve funds when the reserves are commodities like gold and silver than government does not create out of thin air but has to obtain. But a reserve fund makes no sense where governments create settlement balances by fiat, which means “Let it be.”

  17. stanislaus2

    Tom, I’ve shown this quote elsewhere and asked about it, but have not gotten yet an answer to it. Perhaps you could provide the answer:

    “Just as banks create new money when they make loans, this money is extinguished when customers repay their loans as the process is reversed. Consequently, banks must continually create new credit in the economy to counteract the repayment of existing credit. However, when banks are burdened by bad debts and are more risk averse, more people will repay their loans than banks are willing to create new ones and the money supply will contract, creating a downturn.” p. 71

    Ryan-Collins, Josh, Greenham, Tony, Werner, Richard, & Jackson, Andrew (2012). Where does money come from?
    London: New economics foundation.

    Available in Kindle format from Amazon.com

    This describes a basic feature of British banking, and I thought it applied to all banks everywhere.

    Do you agree with it?

    If so, then consider the following quote from “Modern Money Mechanics”, published by the Chicago Federal Reserve Bank:

    “Let us assume that expansion in the money stock is desired by the Federal Reserve to achieve its policy objectives. One way the central bank can initiate such an expansion is through purchases of securities in the open market. Payment for the securities adds to bank reserves. Such purchases (and sales) are called ‘open market operations.'”

    Does the author at the Federal Reserve Bank of Chicago forget that the Treasury issued the security and sold it to a private US bank that created the money out of thin air for a loan of the money to the Treasury made in the form of a purchase of the securities. If what the British authors say is true of most banks, then the money used by the Fed to buy the securities must be extinguished in the act of buying the securities from the banks. Instead of the Treasury taking taxes from circulation to purchase the securities, the Fed has done it with new money it created out of thin air. That Fed money is extinguished, just as the money in circulation would be extinguished were it used to buy back the securities.

    What causes the money supply to increase is not the Fed’s current money created out of thin air to purchase the securities, but the original money in the loan to the Treasury from the banks in their purchase of the securities.
    The deficit spending money received from the banks could be inflationary
    (depending on circumstances), long before the Fed buys up these securities from the banks in QE or OMO. The extinguishing of the banks’ loan by the Fed does not extinguish the original banks’ loan money to the Treasury, since this is different money. The effect of the Fed’s purchase of the securities is just to make the original bank-loan money lent to the Treasury and spent by the Treasury into circulation, debt-free. Nobody is now owed for that money, not even the Fed, since it is acting as an agent of the government in buying the securities. But the debt obligation on the banks’ securities will be extinguished when the Fed takes the mature securities and swaps them for new securities with the Treasury. The Fed will sell these new securities to banks and individuals during inflations to drain money from circulation.

    I am not arguing that the banks lent the Treasury with purely bank money. It lends with money backed by the Federal Reserve by the deposit simultaneously created with the loan to be credited to the Treasury in purchase of the securities for deficit spending.

    This has implications for thinking about Quantitative Easing. If the Fed is buying securities from banks, it is not increasing the money supply with such purchases. Its money is getting extinguished with each security it buys.

    So what do you think about these arguments in the context of your assertions about settlement balances?

  18. The problems arise from not keeping the accounting straight. Just reduce it to the government, consolidating theTreasury and the central bank and non-government, consolidating the banking system. Then it becomes clear that all money created by banks through lending that creates deposits must net to zero. However, when government spends, the net financial assets of non-government increase even if government simultaneously issues government securities as an offset to a deficit. Government creates and provides the funding for net financial saving by non-government in aggregate as well as the funding for taxes imposes. It’s net because it is not in terms of bank credit, which nets to zero by accounting identity.

    Taxes withdraw financial assets from non-government so government spending and corresponding taxation net to zero. When government net spends more than it withdraws in taxes this creates a deficit that increases non-goverment net financial assets in aggregate. When government requires issuance of government securities in offset, the amount of securities corresponding to the deficit is purchased by the settlement balances injected into non-government through net spending. That government’s net spending in the period equivalent to non-government’s net saving during the period.

    Central bank lending nets to zero also because a bank borrowing from the central bank takes a loan liability and gets an asset credited to its settlement balance account, and the central bank makes a loan that it books as an asset and creates a liability by crediting the bank’s account with settlement balances it creates. When the loan is repaid the settlement balances used cancel the loan on the respective books and the central bank liability “disappears” in the same way it was created.

    Conversely when Treasury spends, the the net financial assets of non-government increase as deposit accounts are credited without a corresponding liability ins non-government being created — an assets is added to non-goverent with no corresponding non-government liability. That is to say, deposits increase without any loans being created by non-government, which is net positive for non-government.

    If the government chooses to issue securities when it net spends, as is now customary but not operationally necessary, then the settlement balances that were created in deficit spending that increase non-government net financial assets in aggregate after taxation are used in aggregate to purchase the securities.

    Government securities can only be purchased with settlement balances, which are government liabilities and these enter non-government only through government spending or lending. So amount of government liabilities remains the same, only the forma and term changes from settlement balances to government securities. What happens is that the aggregate non-government net financial assets created by deficit spending get saved as government securities as “safe assets” paying interest, which further increases non-government net financial assets when paid.

    Once government creates net financial assets in non-government in aggregate, they are only diminished by government withdrawing them through taxes, fees, fines, etc that are paid in only settlement balances created by government.

    It might be simpler to get this is one thinks of settlement balances as cash — dollar bills, pound notes, etc — and writes down the transactions in terms of T-accounts. Unless one is experience in accounting or has done this, it will be difficult to keep accounting straight (stock-flow consistent) in one’ head. But what is significant for macro is the sectoral balances which requires consolidating the books of the entitles that constitute the sector. This is done in national accounting, and governments publish reports regularly.

    In summary, a government when government deficit (net) spends it creates net financial assets in aggregate for non-government which are saved as government securities. When a government runs a surplus it net taxes and decreases the amount of net financial assets held by non-government in aggregate. A balanced budget leave non-government net financial assets unchanged in the period.

    Bank lending and loan repayment doesn’t affect this. Consolidated non-government books must net to zero as an accounting identity so that books balance, and therefore bank lending cannot affect non-government net financial assets. Only government can change non-government net financial assets.

    Warren Mosler recommends thinking of financial assets created by government as tax credits. The total of outstanding government securities is the amount of tax credits that haven’t yet been collected in taxes. Paying down the national debt would wipe out these tax credits by withdrawing them and thereby reduce aggregated non-government financial savings in the form of government securities to zero. when government creates net financial assets in aggregate for non-government it accommodates non-government saving desire, which is important in optimizing use of real resources and maintaining full employment.

    The key to understanding financial operations is accounting. Regarding national accounts it is simplest to do this by consolidating sectors and aggregating. This is what macro modeling does in monetary economics. Accurate macro modeling requires an understanding of accounting including national accounts in order to ensure stock-flow consistency. See the following blog posts by Bill Mitchell, Deficit Spending 101, 1, 2 and 3, for example.

    http://bilbo.economicoutlook.net/blog/?p=332

    http://bilbo.economicoutlook.net/blog/?p=352

    http://bilbo.economicoutlook.net/blog/?p=381

    The key to the MMT approach to monetary economics is understanding the difference between bank money that nets to zero in aggregate and aggregate net financial assets created by government for non-government. This is the basis of the sectoral balance approach based on stock-flow consistent modeling developed by Wynne Godley and functional finance developed by Abba Lerner.

  19. “Just as banks create new money when they make loans, this money is extinguished when customers repay their loans as the process is reversed. Consequently, banks must continually create new credit in the economy to counteract the repayment of existing credit. However, when banks are burdened by bad debts and are more risk averse, more people will repay their loans than banks are willing to create new ones and the money supply will contract, creating a downturn.” p. 71

    Ryan-Collins, Josh, Greenham, Tony, Werner, Richard, & Jackson, Andrew (2012). Where does money come from?
    London: New economics foundation.

    In my view this is correct.

    When a loan is made a deposit account is credited, which increases M1 money supply.

    Bank
    Asset: Loan
    Liability: Deposit

    Customer
    Asset: Deposit
    Liability: Loan

    Net zero to non-government. But spendable funds increase in non-government sector through the credit to a deposit account that adds to M1.

    When a loan is repaid, a deposit account is debited and the loan account is credited. That Is the above entries are reversed. The loan is cancelled as a bank asset and the customer’s deposit account is reduced in the amount of repayment. Total deposits in non-government decrease and so does M1 money supply.

    Bank lending is subject to credit conditions that shift cyclically. So deposits tend to increase when credit is looser and decrease when credit is tighter.

    A recession often results when banks tighten credit quickly as a result of a shock that undermines confidence in ability to repay.

    If another sector doesn’t offset the contraction as credit tightens, then the economy will likely contract. It’s unlikely that the external sector will respond quickly, so that leaves government to step up. The automatic stabilizers kick in, for example. If that is insufficient, then the government must add some stimulus through deficit spending to maintain circular flow at a level of full employment.

  20. “If so, then consider the following quote from “Modern Money Mechanics”, published by the Chicago Federal Reserve Bank:

    “Let us assume that expansion in the money stock is desired by the Federal Reserve to achieve its policy objectives. One way the central bank can initiate such an expansion is through purchases of securities in the open market. Payment for the securities adds to bank reserves. Such purchases (and sales) are called ‘open market operations.’”

    Does the author at the Federal Reserve Bank of Chicago forget that the Treasury issued the security and sold it to a private US bank that created the money out of thin air for a loan of the money to the Treasury made in the form of a purchase of the securities. If what the British authors say is true of most banks, then the money used by the Fed to buy the securities must be extinguished in the act of buying the securities from the banks. Instead of the Treasury taking taxes from circulation to purchase the securities, the Fed has done it with new money it created out of thin air. That Fed money is extinguished, just as the money in circulation would be extinguished were it used to buy back the securities.

    What causes the money supply to increase is not the Fed’s current money created out of thin air to purchase the securities, but the original money in the loan to the Treasury from the banks in their purchase of the securities.”

    This is incorrect as I have explained. Banks cannot create settlement balances required to purchase government securities. Think of settlement balances as cash. Can banks print cash to buy government securities? Of course not. Settlement balances and vault cash make up the total reserves of private banks. Settlement balances and cash are interchangeable at par at the central bank. If banks could convert their own IOUs directly into cash then the government would lose control of its money. Banks cannot do this. They have to exchange settlement balances that are liabilities of the central bank for cash.

    Government doesn’t borrow from private banks with deposits they create to fund itself in a modern monetary economy with a Treasury and central bank. Government is the sole provider of the currency. Everyone else is a currency user. This is absolutely basic, but some economists are just getting this and many haven’t figured it out yet because they don’t t think in terms of accounting and operations.

    • stanislaus2

      I have asked you Tom to discuss how the Treasury gets money for deficit spending.
      As I see it the Treasury borrows money from banks. Because borrowing involves a loan, and banks can and do create loans with money out of thin air (rather then using the money of its current depositors), the banks also create the money for these loans out of thin air.
      But you talk about settlement balances at the Fed. These must be given to the banks in exchanges for their dollars they create. This gives the banks’ dollars legitimacy. But the banks are part of the process and the amounts that they pay for the securities are up to them in the auction. The Fed it seems to me only sanctions these dollars in exchanging them for settlement balances you describe. The Fed is not likely to refuse to provide these settlement balances. That would be contrary to the smooth functioning of capitalism.

      So, I do not feel that anything you say about settlement balances needs be discounted or denied. It is just to be taken for granted as we talk about the Treasury borrowing money the banks create out of thin air. And thus we need to consider how these loans from the banks to the government are recorded on the books of the banks when the Fed intervenes to buy the securities, thus switching the debt obligation of the government to the Fed
      from the banks. But it seems from the general idea that bank loans when paid off by someone are extinguished and the payoff money is extinguished also as it is with all loans.
      Suppose Joe borrows $100 from bank A. Later Bill pays off Joe’s loan with $100 of his own. Bill may not insist that Joe pay him back for the deed of redeeming Joe’s debt. Still Bill’s $100 are extinguished while Joe’s $100 remains in circulation. Joe’s $100 are now debt-free to their original source at the banks. The banks don’t have an additional $100 dollars over and beyond those they lent to Joe. I assume that Bill also pays off any required interest to the bank.
      That’s the paradigm I am considering when I say that when the Fed buys US Treasuries from banks who got them ultimately from the Treasury for deficit spending, the Fed’s money is extinguished and should not be reported to continue in existence at the banks except maybe as vault cash or settlement balances.
      But the banks don’t have them to spend on themselves.

  21. “This has implications for thinking about Quantitative Easing. If the Fed is buying securities from banks, it is not increasing the money supply with such purchases. Its money is getting extinguished with each security it buys.”

    Incorrect. There was a huge increase in M1 beginning with QE. And bank lending was not the reason for it.

    https://research.stlouisfed.org/fred2/graph/?s%5B1%5D%5Bid%5D=M1

    In QE, the central bank is simply shifting funds from time accounts (securities) to deposit accounts (settlement balances) at the central bank. Non-government net financial assets in aggregate are not affected.

    If banks sell securities they own, then the settlement balances that the central bank creates to purchase the securities sit at the central bank in the bank’s reserve account there, which is not figured in M1 money supply. Spendable funds are not affected. Banks don’t lend out settlement balances either. They are used only for settlement and remain in the payments system where they reside on the central bank’s spreadsheet.

    If a non-bank sells securities that the central bank purchases, then the seller’s bank’s account at the central bank is credited and the bank credits the seller’s deposit account, and M1 therefore increases. This increase in M1 can be used either for spending or saving, e.g., by saving at the bank or elsewhere.

    The central bank as no control over what happens other than one its own spreadsheet. As a matter of fact, most of the increase of settlement balances in non-back deposit accounts went into purchase of other saving vehicles, driving up asset prices rather than into firm investment spending or household consumption. So QE resulted mostly in portfolio shifting. Actually, the central bank anticipated this and believed that this would create a wealth effect that would increase spending indirectly. That didn’t happen much.

    QE blew always several erroneous assumptions. First, that lowering the policy rate and flattening the yield curve would result in increased investment by firms. Secondly, that increasing the amount of settlement balances would increase inflation expectations due to increased lending and spending. Thirdly, the theory of the money multiplier was shown to be erroneous as the endogenous money people had been saying. Since this is the basis of monetarism, a lot of conventional economists were flummoxed and still haven’t accounted for it with their inadequate models.

    • stanislaus2

      Stanislaus2 said:“This has implications for thinking about Quantitative Easing. If the Fed is buying securities from banks, it is not increasing the money supply with such purchases. Its money is getting extinguished with each security it buys.”

      Tom: “Incorrect. There was a huge increase in M1 beginning with QE. And bank lending was not the reason for it.

      https://research.stlouisfed.org/fred2/graph/?s%5B1%5D%5Bid%5D=M1

      What I said above seems to have been interpreted differently than what I intended: I am talking about the Fed’s buying US Treasury Securities from the banks. You seem to be interpreting it as the Fed buying securities issued by the banks as liabilities of the banks. I’m concerned with securities the banks got by lending money for deficit spending to the Treasury in return for the IOU’s, the US Treasury securities. These securities are monetary liabilities of the government to the banks.

      The graph you show may still be based on a misinterpretation of what happens when the Fed’s newly created money (out of thin air) gets put into the banks’ reserves in return for the US Treasury securities possessed by the banks. Sure it may look like M1 there, but have the banks applied that money to the loans they made to the government in buying the securities which were liabilities of the government to the banks?

      Given what I think is a misinterpretation in Modern Money Mechanics by whomever authored the manual at the Chicago Fed, I would have to be suspicious of this graph you show. The Chicago Fed manual was treating expanding the money supply by buying US Treasury securities held by the banks. But what they are actually describing is a swap of a real asset for money.

      But a security is not a real asset, not property, not a thing, not a bunch of goods: it is an IOU for a debt or loan. The obligation is monetary and is on the issuer to whomever holds the IOU.

      If the Fed were authorized to buy goods with money it creates out of thin air, then there would be an increase in the money supply at the banks in return for the goods. It seems to me that this manual has been a source of much confusion on how the Fed increases the money supply.

      If the Fed had bought with Fed money a bunch of loans issued by the bank, that money should have extinguished the loans at the banks in return for the loans. The Fed’s money would also be extinguished in the process. The Fed would then have to go to the borrowers of these loans for redemption of the loans.

      In this case swapping the mature US securities received from the banks for new securities issued by the Treasury with new future maturity dates would be a way for the Fed to extinguish the government’s obligation to it on the mature securities.

      The Treasury could then extinguish the securities themselves on receipt of them from the swap.

      I agree that the Fed is not obligated in any way when it buys a security issued by a bank from that bank.

      But the banks didn’t issue the US securities they bought from the Treasury. And these are the securities I am talking about. QE bought almost all that were mature from the banks. The Fed has been canceling the national debt on the deficit. The national debt to investors is another matter and handled in another way. No need for platinum coins here.

  22. The only way that non-government can get Treasury securities in the first place is to purchase them from the government that issues them using settlement balances obtained from government. Checks drawn on banks settle in settlement balances that are only issued by government.

    When the Fed conduct OMO or POMO (QE), all that happens is that the government securities are exchanged for settlement balances or settlement balances for government securities, depending on the direction of monetary policy.

    The simple way to explain this is that fiscal operations add to or subtract from the net financial assets of non-government in aggregate, while monetary policy does not affect the total of net financial assets held by non-government in aggregate. In short, only the fiscal authority is permitted to tax and spend, and only the monetary authority is permitted to provide liquidity in the payments system and to set the policy rate using tools of monetary policy that don’t affect fiscal stance.

    The fiscal authority loosens policy by spending more than taxing and tightens buy taking more than spending.

    The monetary authority loosens monetary policy by lowering the policy rate and tightens by raising it. QE tends to flatten the yield curve lowering longer term rates by bidding up the price of bonds (price is inversely proportional to yield). The policy rate and yield curve are benchmarks for private lending rates.

    • stanislaus2

      The only way that non-government can get Treasury securities in the first place is to purchase them from the government that issues them using settlement balances obtained from government. Checks drawn on banks settle in settlement balances that are only issued by government.

      What money do the banks use to purchase these settlement balances? Where do the banks get this money? Why does the government accept money which is not automatically settlement-balance dollars?

      Are loans to bank borrowers (customers) in settlement balance dollars?
      Or are their loans just between borrowers and banks? But that money gets mixed in circulation with settlement balance dollars, no? So, how do we know whether a given dollar is a settlement-balance dollar or a private bank dollar?

    • stanislaus2

      The only way that non-government can get Treasury securities in the first place is to purchase them from the government that issues them using settlement balances obtained from government. Checks drawn on banks settle in settlement balances that are only issued by government.

      When Chinese investors purchase US securities with dollars they have collected from selling imports in the United States, where do they get the settlement balances to make the purchase?

      I presume that the Chinese do not initially have settlement balance dollars.
      So, do they get them by exchanging their dollars for settlement balance dollars at the Treasury?

      Where do State pension funds get their settlement balance dollars to buy US Treasuries?

      The idea that the system has this two-tiered monetary system that at certain points require holders of nongovernment money to exchange them for government money is difficult for me to digest.

      What makes it possible for the nongovernment to exchange its dollars for settlement-balance dollars? Why can there be a one-to-one correspondence between these dollars (if there is one). Is there law that directs the government agencies to accept private bank dollars in one-to-one exchanges for settlement-balance dollars?

      It looks to me that the money-like metaphor of settlement-balances reifies what is essentially just entries in a different spread sheet than that kept at private banks. The exchanges make it possible for entries on private bank spreadsheets to be entered onto the Fed’s spreadsheet. Could we simply use Occam’s Razor here and make just a single monetary unit, the dollar, and simply note that it gets recorded in different spreadsheets under certain circumstances?

      I am prepared to think of bank dollars as the greatest part of dollars in circulation. Somehow there needs to be something that unifies all the various kinds of dollars into variations of a single thing, the dollar.

  23. “If the Fed had bought with Fed money a bunch of loans issued by the bank, that money should have extinguished the loans at the banks in return for the loans.”

    In QE1, the Fed bought MBS (mortgage backed securities) from the banks in addition to Treasuries.

    Fed
    Asset: Treasuries and MBS
    Liability: Settlement balances credited to the sellers.

    Sellers (banks)
    Asset: Credit to settlement account
    Asset: Debit to securities account

    The banks’ settlement and securities accounts are both asset accounts so one asset was switched for another on the banks’s books.

    As new owner the securities, the Fed assumed the default risk instead of the banks as former owners. In case of default the Fed would take the loss by deducting loans as an asset and writing down equity. In this way, risk was transferred from the private sector, chiefly banks, to the public sector. This affected the weighting of bank capital (equity) which was important at the time of the crisis.

    “The Fed’s money would also be extinguished in the process. The Fed would then have to go to the borrowers of these loans for redemption of the loans.”

    The Fed’s settlement balances went to the banks that owned the loans. The banks were “made good” by the central bank who assumed their risk on loans that might not be fully recoverable. The Fed simply assumed the loan and borrowers who took out the loans then had to pay principal and interest to the Fed rather than the bank that issued the loan. If the loan went into default, then the Fed could attempt to recover what it could from the borrower as the bank would have done.

    Why was it necessary for the Fed to buy the loans? The loans were dodgy and if marked to market or the bank tried to sell them in the market, they would be discounted and the bank would lose money on the loans. The banks were under pressure at the time so the Fed bought the loans at full value to get the banks off the hook. The rationale for this largesse was saving the US and global financial system from collapse.

    • stanislaus2

      If the Fed had bought with Fed money a bunch of loans issued by the bank, that money should have extinguished the loans at the banks in return for the loans.

      In QE1, the Fed bought MBS (mortgage backed securities) from the banks in addition to Treasuries.

      Fed
      Asset: Treasuries and MBS
      Liability: Settlement balances credited to the sellers.

      Sellers (banks)
      Asset: Credit to settlement account
      Asset: Debit to securities account

      The banks’ settlement and securities accounts are both asset accounts so one asset was switched for another on the banks’s books.

      The banks should apply the Fed dollars (settlement-balance dollars) to the loans implicit in the MBS, no? Does this not extinguish the loan and the Fed dollars used to buy them on the banks’ books? The Fed now has the Treasuries and the MBS. Doesn’t the settlement balances credited to the sellers cancel the debt of the MBS mortgagees to the bank and transfers their debt to the Fed? The Fed’s purchasing money should now be extinguished since it canceled loans.

      Similarly, the Treasury securities were loans of the banks to the govt via the Treasury, bought by the banks with dollars converted to settlement-balance dollars at the auction where they bought them. If the Treasury had bought these securities with money raised by tax revenues, the money would have come from circulation and would have extinguished the debt and extinguished the dollars raised from circulation. Isn’t the money in circulation settlement-balance dollars for the most part? If so, how?

    • I think I must be using the wrong terminology when I say extinguish the loans when the Fed buys them. I’m referring to the fact that the banks are clearing their books of these loans by selling them to the Fed. What should we call that? Using this terminology creates misunderstanding.

  24. “No need for platinum coins here”

    The platinum coin gambit is about increasing settlement balances in the Treasury account to meet expenses at the time that Treasury could not issue more securities for auction owing to the debt limit. The Fed is not permitted by Congress to just credit the Treasury account or lend directly to the Treasury. But it can purchase coins minted by Treasury and pay for them by crediting the Treasury account with settlement balances.

    It’s about providing liquidity to the Treasury to clear its checks in the payments system when Treasury is not permitted to issue more securities owing to have hit the debt limit. The platinum proof coin would have allowed the Fed to provide the Treasury with ample liquidity legally, it was claimed, thereby circumventing the debt limit by direct issuance.

    There is no problem operationally with direct issuance but it is not permitted by law in the US at this time. Lincoln did it in the case of greenbacks as an emergency measure to fund the war.

    • stanislaus2

      I agree with what you say was the purpose of the platinum coin. But that does not mean it is necessary. The point I make about the Fed buying up the securities is that it is canceling the deficit debt of the govt to the banks (but not yet canceling the debt obligation of the government to the holder of the securities for the face value of the securities at maturity). And that means that the deficit spending portion of the national debt is being essentially retired through the efforts of the Fed’s QE. Most austerians believe the national debt is exclusively for deficit spending, which it is not. You can look at pie graphs in consecutive years from 2007 to 2014 of the constituents of the national debt. In the first place the US securities held by the banks in any year is quite small relative to the rest of the national debt. In 2010 banks held just 4% of the non-governmental public debt. The Fed held 9% that it had bought from the banks. 87% were held by nonbank investors. In successive years the amount held by the banks is on the order of the actual deficit for that year (principal represented securities at banks) plus what I guess to be interest loans to the government via securities. In the meantime the Fed was doing its QE and weeding out the mature US securities along with all the toxic assets. The Fed’s portion increases in the mature securities it bought from banks in that succeeding year. What remains in the banks I think is the current fiscal year’s borrowing represented by securities bought by the banks from Treasury plus interest securities bought from Treasury. This was something no one had noticed publicly before that I was aware of: The Fed was buying back the national debt for deficits from the banks who lent the money to them. It will then swap them if and when they mature for new securities from the Treasury. (This procedure is described in the Chicago Modern Money Mechanics at what I think is the bottom of page 34 with the title “Maturing securities”. That’s how mature US securities obtained by Fed from banks get extinguished when returned in swaps for new securities. It’s legal because no cash is exchanged between Fed and Treasury. But the Fed waits until there is inflation to make these swaps (which I infer simply because it is the only rational thing for the Fed to do in this case, because it will sell these new securities to banks and investors to drain excess cash out of circulation in fighting inflation. Make the swaps only when the maturity dates will be at a decent interval in the future and marketable).

  25. “What money do the banks use to purchase these settlement balances? Where do the banks get this money? Why does the government accept money which is not automatically settlement-balance dollars?”

    You have not yet understood the dual process of money creation in which only government issues currency and banks leverage credit off the currency, in the sense that a bank credit is a promise to clear in the government’s money, either by providing cash at the window on demand that the bank can only obtain from government or from cash deposits in which the cash had come from the government previously. The same applies to settlement balances.

    Settlement balances are entries on the spreadsheet of the central bank that are created by the central bank keystroking accounts on its spreadsheet. Settlement balances come either from government spending by the Treasury or government lending by the central bank. Banks get settlement balances credited to their accounts either from credits to their accounts from Treasury spending or borrowing from the central bank, or selling securities to the Fed.

    Government securities come only from Treasury and government agencies and are purchased only with settlement balances. Banks can’t buy Treasury securities or get cash by issuing credits to a bank deposit account that they credit. They have to purchase them from the Fed in settlement balances that only the Fed issues.

    Settlement balances that the banks use to settle with each other in the interbank market and with the government come from Treasury spending that credit’s banks’ settlement balance accounts at the Fed or from borrowing at the Fed by putting up government securities as collateral, or using the discount window at the penalty rate The Fed sets. Banks with excess settlement balances lend to banks that need settlement balance at the policy rate that is set by the Fed. This is the Fed funds rate.

    The US banking system is hierarchical with government at the apex, followed by banks with access to the payments system, followed by lenders that don’t have access to the payments system. A bank can only keystroke its own books. When a bank makes a loan it records the loan as an assets and credits a deposit account as its liability. The deposit is an asset for the borrower and the loan is a liability. Net zero. Consolidating the non-government banking system, all books balance and the net is zero.

    Consolidate conceptually all banks into one bank. Then it is clear that after accounts are netted, final settlement in the payments system run by the government can only come from government, conceptually consolidating the Treasury and Fed.

    It’s simply a misconception that banks lend the government that they create in purchasing government securities. That is not the way it works operationally. Similarly, banks don’t get cash by paying with their own self-created liabilities.

    • I’m still having some problems with the following:

      Settlement balances are entries on the spreadsheet of the central bank that are created by the central bank keystroking accounts on its spreadsheet. Settlement balances come either from government spending by the Treasury or government lending by the central bank. Banks get settlement balances credited to their accounts either from credits to their accounts from Treasury spending or borrowing from the central bank, or selling securities to the Fed.

      How does the auction know whether the bank’s money comes from previously acquired settlement balances or the banks creation of the money?
      Suppose it is a mixture of both kinds of dollars…

      I would rather see the auction accepting any dollars created by the bank or acquired by the bank and converting these by making them settlement balances….

      Government securities come only from Treasury and government agencies and are purchased only with settlement balances. Banks can’t buy Treasury securities or get cash by issuing credits to a bank deposit account that they credit. They have to purchase them from the Fed in settlement balances that only the Fed issues.

      Is this simply the notion that the Fed needs to be informed of these purchases so it can put them on its books, or is there some special
      reason for having banks purchase these settlement balances to be able to purchase the securities? In the first case, the transaction could be communicated to the Fed so that the record of it can be put in the Fed’s spread sheet. But the having the settlement balances purchased is a more complicated process, and may place limits on bank lending.

      But you say banks can’t buy securities from the Treasury with just any ordinary dollars. That means the banks can’t essentially create money out of thin air to buy these securities. The banks must have acquired the special money for this buying previously. To me this puts ultimately a limitation on the banks providing funds for purchasing US Treasuries. It suggests that there may be at some point an upper limit to the amount of money that the banks can come up with to buy these securities with. This doesn’t sound like the freedom we preach to be able to pay any deficit that may arise in our doctrine on fiat money. And it would actually make the Treasury’s method of paying interest a Ponzi scheme when at some point no bank can lend the Treasury to buy its offering of securities. What do you think?

      Government securities come only from Treasury and government agencies and are purchased only with settlement balances. Banks can’t buy Treasury securities or get cash by issuing credits to a bank deposit account that they credit. They have to purchase them from the Fed in settlement balances that only the Fed issues.

      Settlement balances that the banks use to settle with each other in the interbank market and with the government come from Treasury spending that credits banks’ settlement balance accounts at the Fed or from borrowing at the Fed by putting up government securities as collateral, or using the discount window at the penalty rate The Fed sets. Banks with excess settlement balances lend to banks that need settlement balance at the policy rate that is set by the Fed. This is the Fed funds rate.

      Are there documents to read about these settlement balance dollars you refer to?

      The US banking system is hierarchical with government at the apex, followed by banks with access to the payments system, followed by lenders that don’t have access to the payments system. A bank can only keystroke its own books. When a bank makes a loan it records the loan as an assets and credits a deposit account as its liability. The deposit is an asset for the borrower and the loan is a liability. Net zero. Consolidating the non-government banking system, all books balance and the net is zero.

      For some reason I thought each bank’s spreadsheets were copied and kept at the Fed as the bank’s reserves. Today, with computers this seems plausible. It would be a way for the Fed to know and record as settlement balances certain purchases of securities by banks, among other things.

    • Tom, I’m still struggling with how you merge settlement balance dollars with bank created loan dollars:

      Settlement balances are entries on the spreadsheet of the central bank that are created by the central bank keystroking accounts on its spreadsheet. Settlement balances come either from government spending by the Treasury or government lending by the central bank. Banks get settlement balances credited to their accounts either from credits to their accounts from Treasury spending or borrowing from the central bank, or selling securities to the Fed.

      I can imagine banks creating loans that never get converted into cash (bills and coins) but circulated via credit cards and electronic bank transfers. Your account suggests that there are two kinds of dollars, settlement balance dollars and, let us call them, ‘US Bank loan dollars’ or “bank dollars” for short.

      Now, British banks supposedly generate about 95% of the pounds in circulation by making loans. I imagine that the US banks generate a very large proportion of the dollars in circulation, and these should be bank dollars.

      I can’t imagine that the Treasury is ‘borrowing’ all that much relative to the dollars created by bank loans out of thin air, so the Trsry’s dollars are much less than the bank dollars.

      Government securities come only from Treasury and government agencies and are purchased only with settlement balances. Banks can’t buy Treasury securities or get cash by issuing credits to a bank deposit account that they credit. They have to purchase them from the Fed in settlement balances that only the Fed issues.

      I can imagine cases where there are purchasers of US bonds and securities who do not have settlement balance dollars–but only bank dollars. How can they get the settlement balance dollars with which to purchase the securities? If I were to take out a loan of $10,000 from my bank and then immediately applied for purchase of a US Treasury security at the Treasury for $10,000, would I be denied the sale? How would the Trsry know which dollars I used? I would pay with either a check of electronic fund transfer of my own from my checking account, which had the loan money.

      Or does the government agency, create the settlement balance dollars and replace my bank dollars with the settlement bank dollars, extinguishing my bank dollars. The sale of the securities then proceeds with the settlement bank dollars.

      I don’t see why a US bank can’t just create the loan needed by the Treasury for purchasing the security at auction, with the auction brokers (as agents for the government) replacing the bank’s dollars with settlement balance dollars. The bank doesn’t pay cash, but with US bank dollars. The auction brokers don’t just exchange but replace the US bank dollars with settlement balance dollars. That makes the securities federal money.

      In fact, the brokers just see dollars and accept them as such without further ado and complete the sale for the bank (if it wins the bidding at the auction). There is no need for a formal exchange. The Fed will know about them once these dollars are entered into the Treasury’s accounts.

      As for getting settlement balance dollars from the Fed in sales of securities to the banks, there still remains the unresolved issue of how the bank in making a loan, even to the Treasury, should have a debit on a deposit account that it created to make the loan, resulting from sending the dollars from that deposit to the auction and ultimately the Treasury. The dollars the banks receive from the Fed for the securities go into the banks’ reserves. But shouldn’t those dollars be applied to the debited loan deposit account, thus extinguishing the dollars from the Fed.

      Work through for me the steps by which the bank creates the loan it will make to the Treasury when it buys the security. Is there not something like
      loan is created and simultaneously a deposit is made in a new US bank reserve account. The money is then withdrawn from that account and put in the Treasury loan account, and the money sent to the Treasury (or the auction). Now, the Fed intervenes and purchases the security after it is given to the bank. The Fed dollars are keystroked into the banks’ reserve accounts. To clear the books of that account not only is the Treasury loan account erased but to erase the debited bank deposit account it must first be cancelled by the netting of the Fed’s created dollars now in the banks’ reserves.

      OK what is wrong with that?

    • Tom said:
      You have not yet understood the dual process of money creation in which only government issues currency and banks leverage credit off the currency, in the sense that a bank credit is a promise to clear in the government’s money, either by providing cash at the window on demand that the bank can only obtain from government or from cash deposits in which the cash had come from the government previously. The same applies to settlement balances.

      Settlement balances are entries on the spreadsheet of the central bank that are created by the central bank keystroking accounts on its spreadsheet. Settlement balances come either from government spending by the Treasury or government lending by the central bank. Banks get settlement balances credited to their accounts either from credits to their accounts from Treasury spending or borrowing from the central bank, or selling securities to the Fed.

      Tom, I now think I see why I am having difficulty with your account here. In the case of deficit spending by the Treasury borrowing from the banks, it does not allow for new settlement dollars to be entered into the economy that are debt-free. It emphasizes how the money must come from the Fed but it either makes it money already currently spent into the economy in the form of Treasury spending (in the past), or debt-laden money in loans from the central bank. There is no selling securities to the Fed in the process of borrowing from the banks.

      Money already spent by the Treasury into circulation is already in circulation when the new deficit spending needs funding. If the bank has to acquire that money from elsewhere before it can lend it to the Treasury as settlement balances, then this process does not involve creation of new money out of thin air by the banks or the Fed and further this is only a transfer of old settlement balances to the Treasury which simply cycles them back into the economy. There is no net gain of new money into the economy.

      If the banks have to borrow the settlement balances from the Fed, then that involves a debt the bank at some later point must pay. And these do not solve the national debt problem for deficit spending.

      There seem to me to be only a few ways in which these settlement balances must be provided, debt-free, to the banks when they loan money to the Treasury.

      They could be made as new Federal reserve deposits when the loan deposit is created. The monetary system simply does this. It is not an issue of bank money versus settlement balances; it is both. “A licensed US bank has the power to create new settlement balances when it creates loans.” This seems to me to be the most direct way. In this way US bank dollars are automatically new settlement balances at creation. They are automatically noted on the books at the Fed. They cannot be counterfeit. They are not printing money: the mint under the Treasury does that. Initially they are creating new settlement balances with the Fed. That makes the conversion of them into coins and bills seamless.

      Or a bank reserve account could automatically be created by the Fed depositing equivalent settlement balance dollars when the loan is created for deficit spending. But I think doing this in this limited way would be inefficient for other lending activities of the bank and the need for that money to be exchanged into coin and bills (settlement balances among others). The bank cannot promise to issue coins and bills when customers demand them at withdrawals from the bank. The promise could not be made unless there was some preceding commitment of the Fed to provide that. And the Fed needs to exchange them for settlement balances of the bank. And it should do this, not as loans, but as direct credit without strings attached.

      I don’t know if this is actually what occurs, but it seems to me to be the most rational and direct way to set things up in a fiat system. Otherwise, it seems convoluted the way some accounts describe what happens.

      Other ways beyond the bank at the auction strike me as cumbersome. The primary dealers shouldn’t have to go through hoops to accept the banks’ dollars as payment for the securities.

  26. “Most austerians believe the national debt is exclusively for deficit spending”

    A deficit and a surplus are accounting record of flow over a period. A deficit means that expenditures were greater than revenue and a surplus that revenue was greater than expenditure. This shows up on the income statement, also called the profit & loss statement (P&L).

    Revenue = Expenditure + Profit (Loss).

    Debt is a stock that the flow adds to in the case of a deficit or subtracts from in the case of a surplus. This shows up on the balance sheet.

    Assets = Liabilities + Equity

    When the government spends more than it taxes, it runs a deficit, and if security issuance is required as a deficit offset, then the amount of the deficit corresponds to the additional securities that the government issues, which increase the accumulated debt.

    The securities simply switch the settlement balances added to banks’ settlement balance accounts at the Fed. This is like switching funds from a demand account to a time account. The funds that purchase the securities are provided by the spending.

    This is what happens in aggregate in the system, which is simple to see if one consolidates the various entities into sectors for the purpose of analysis. Where people get confused is in looking a what happens at the level of entities and not following through on all the accounting involved.

    Where the austerians go wrong is in thinking that there is a lump of money that government and private firms compete to borrow, so that government borrowing “crowds out” investment. This is wrong because government provides the funds as the settlement balances credited to non-government by government spending and with which the securities issued are purchased in aggregate. Moreover, there is not a lump of money fixed by the amount of savings because banks create bank credit in issuing bank loans. The austerians don’t understand either operations or accounting.

    • stanislaus2

      My view on the national debt is that it is held by three entities: (1) banks,
      (2) investors (3) intragovernmental series securities. How the debt is managed differs in each case.

      (1) Treasury borrows money from banks by selling them securities to obtain money for deficit spending. When the securities mature, the Treasury just pays the interest and issues new securities which it swaps for the banks’ mature securities. It will do this over and over forever so that the principal is never paid back, only interest at each swap. The Treasury gets interest also by selling securities to banks. And it rolls over these securities with swaps in the same way so the principal of the interest loans is never paid off either.

      This procedure makes the money obtained from the securities for all practical purposes debt-free, since a debt whose principal is never to be paid is not a real, ordinary debt. So, it doesn’t matter how large the accumulated principal is, piecemeal it is tractable, and in aggregate never to be paid.

      (2) Investors also buy US Treasury securities with dollars they have accumulated. This money is never used to pay for the deficit spending of Congress, i.e. government operations. It is kept in time deposit accounts at the Fed. It is there to be returned to the investors on demand at maturity of the securities. These debts may be rolled over by issuing new securities and swapping them for the mature securities on the principal and paying interest on the mature securities.

      So, the money is always there to pay back the investors in the time-deposit accounts at the Fed. No problem there.

      (3) The intragovernmental series securities cannot be bought directly by the Fed. But the Treasury can buy them if it has dollars. It can get these dollars as needed by borrowing from the banks using marketable securities. So, there is a way to buy these securities and redeem them. The Fed can buy the marketable securities used to raise this money with money it creates out of thin air. Then it will swap these securities for new securities with the Treasury which extinguishes the marketable securities used to raise the money for buying the intragovernmental securities. No debt problem either.

  27. “The point I make about the Fed buying up the securities is that it is canceling the deficit debt of the govt to the banks (but not yet canceling the debt obligation of the government to the holder of the securities for the face value of the securities at maturity). And that means that the deficit spending portion of the national debt is being essentially retired through the efforts of the Fed’s QE.”

    This is a bit complicated by the rules. The Fed’s buying government securities doesn’t cancel the debt, which remains on the government’s consolidated books even thought the government owes the funds to itself. That is to say, for the purpose of the debt ceiling the amount of debt is not changed by QE purchases even though the securities are an asset of the Fed and liability of the Treasury, which are both government agencies.

    Some have suggested just recognizing the accounting and canceling the debt that the Fed has purchased. But so far that hasn’t happened in Congress, probably because austerians think that this is “monetizing the debt,” which is considered “fiscally irresponsible.”

    The austerians advertise themselves as being about “fiscal responsibility” when their actual objective is to limit the fiscal space of the government and thereby shrink the welfare state with the objective or creating a market state. This is the neoliberal aim.

    The way to do this is to act as if the country were still on a gold standard (fixed rate convertible monetary system) rather than on the current floating rate non-convertible system. Alan Greenspan admitted that this was his modus operandi.

    As result there is a lot of obfuscation about what is going on even when the people in charge actually understand the accounting and operations. They don’t want ordinary folks peeking through the veil.

    • stanislaus2

      “The point I make about the Fed buying up the securities is that it is canceling the deficit debt of the govt to the banks (but not yet canceling the debt obligation of the government to the holder of the securities for the face value of the securities at maturity). And that means that the deficit spending portion of the national debt is being essentially retired through the efforts of the Fed’s QE.”

      This is a bit complicated by the rules. The Fed’s buying government securities doesn’t cancel the debt, which remains on the government’s consolidated books even thought the government owes the funds to itself. That is to say, for the purpose of the debt ceiling the amount of debt is not changed by QE purchases even though the securities are an asset of the Fed and liability of the Treasury, which are both government agencies.

      OK, I think I have erred in thinking that when you buy some debt (loans, securities, mortgates), you cancel the loan. The loan gets transferred to the buyer of the loan, and the borrower has to redeem the debt through the new holder of the loan.

      But what I have been thinking about is how the Fed’s buying securities must cancel the govt’s debt to the banks, but still this does not cancel the debt obligation of govt to the new security holder. The original lender (e.g. the banks) has made a deposit into an account from which dollars are transferred to the checking account of a borrower (debiting the deposit account), and that money has left the bank, and there must be a debit somewhere on the books until money comes back to either cancel the loan or pay off the lender so that he can transfer the loan to the new holder of the loan. That new money must be netted with the debit to the deposit account.

      Carrying that idea over to the case of the securities bought by the Fed from banks, the Fed’s dollars created out of thin air are added to the banks’ reserves and must then be applied by the bank to its balance sheet. Those dollars from the Fed must be netted with the debit to the loan deposit to clear the accounts of the bank of the securities. But that only happens at the bank. The money lent to the Treasury and deficit spent into the economy still circulates, now debt-free, when the Fed takes the securities and swaps them for new securities with the Treasury.

      QE cannot just add gobs of money to banks’ balance sheets without its being reduced in quantity by netting this money with debited deposit accounts associated with these securities and loans and CDO’s. This occurs even as the owner of the securities shifts to other banks or the FED in these sales of the securities and loans.

      But whether the banks have gobs of dollars in their reserves or not does not matter, since in any case they cannot access those dollars for making loans, right?

      • The problem I have with not having the Fed’s buying extinguish its money against a debited deposit account created by the loan, is that otherwise this effectively adds twice the money for the deficit spending: (1) When the banks directly lend the new money they create out of thin air to the govt (in the Treasury) (2) when the Fed intervenes and buys the securities instead of leaving them alone to be rolled over and over by the Treasury. Or does the Fed’s money never go into circulation? The issue is whether this money is inflationary depending on the circumstances.

    • I make a distinction between canceling the debt TO THE BANKS and just canceling the debt on the securities.
      This is a bit complicated by the rules. The Fed’s buying government securities doesn’t cancel the debt, which remains on the government’s consolidated books even thought the government owes the funds to itself. That is to say, for the purpose of the debt ceiling the amount of debt is not changed by QE purchases even though the securities are an asset of the Fed and liability of the Treasury, which are both government agencies.

      Eventually the Fed will swap these mature securities it got from the banks for new securities from Treasury. When the Treasury receives the mature securities, they have returned to the issuer, and being mature, cannot be discounted and thus sold. Thus they are extinguished or locked up in some deep vault somewhere. That’s where and when the debt of the securities gets completely extinguished.

  28. “The banks should apply the Fed dollars (settlement-balance dollars) to the loans implicit in the MBS, no? Does this not extinguish the loan and the Fed dollars used to buy them on the banks’ books? The Fed now has the Treasuries and the MBS. Doesn’t the settlement balances credited to the sellers cancel the debt of the MBS mortgagees to the bank and transfers their debt to the Fed? The Fed’s purchasing money should now be extinguished since it canceled loans.”

    The Fed is not allowed to give the banks funds to pay the loans they hold. The Fed can only purchase the loans and put them on the government’s books instead of the banks’ books. The loans were not cancelled by the transfer of ownership.

    The Fed would have had to ask Congress for permission to do that, and it didn’t. It’s understandable since the Fed had to act quickly and there might have been a political firestorm if the Fed had gone to Congress about doing this.

    Actually, it’s what happened in effect anyway, since most of the MBS involved Fannie and Freddie and they were eventually nationalized so government would have eaten the loans anyway.

  29. “Similarly, the Treasury securities were loans of the banks to the govt via the Treasury, bought by the banks with dollars converted to settlement-balance dollars at the auction where they bought them. If the Treasury had bought these securities with money raised by tax revenues, the money would have come from circulation and would have extinguished the debt and extinguished the dollars raised from circulation. Isn’t the money in circulation settlement-balance dollars for the most part? If so, how?”

    Settlement balances exist only on the Fed’s spreadsheet as entires in different accounts. Non-banks don’t use settlement balances.They are used only for settling accounts at the Fed by those who have accounts at the Fed.

    The Treasury has an account through which the Fed settles accounts for the Treasury, and member banks have accounts for settlement with the government and with each other. Countries also have accounts for international settlement. There are two types of account. The first is like a demand deposit account. The credits in this account are settlement balances. The other type of account is like a time account. The credits are government securities. These accounts are switched back and forth without changing the amounts, only the type of account.

    Settlement balances are used by banks to exchange for vault cash to meet window demand. Cash in circulation is cash that is passed over the window to customers. Cash is used for spot transactions in the economy. It is not used to settle with government although a small amount may still be used for the purpose. Government discourages cash payment due to transaction cost. It’s more efficient to use the payments system. So bank customers deal in bank credit and banks act as agents in converting their own credits into government credits in the form of settlement balances, which they get from borrowing since they can’t create them.

  30. Banks do two things, essentially, lend and borrow.

    Banks make loans against collateral by discounting the collateral. The downpayment is a discount, for instance. In making a loan, the bank creates an asset for itself — the loan — and also a corresponding liability for itself — a deposit. The customer borrows from the bank and the bank borrows from the customer. The customer has to repay the loans with interest and the bank has to settle the deposit when the customer no longer wished to save at the bank, possibly with some interest, too.

    The bank has “borrowed short and lent long,” since it is assumed that the customer will withdraw the deposit that the loan created before the loan is repaid with another deposit.

    When the customer withdraws the deposit either as cash or by a draft on the account, the bank has to settle, either by passing cash through the window or by settlement intra or inter-bank. After netting, the bank must obtain settlement balance to do so, just as it has to obtain cash to meet window demand.

    For example, if the customer presents a draft drawn on the bank to another bank, then the settlement takes place through netting initially with final settlement in the payments system using settlement balances.

    Banks borrow settlement balances they needs for operations and to meet reserve requirements if any. The Fed imposes a reserve requirement, while the Bank of Canada doesn’t.

    Banks borrow settlement balances from each other in the interbank market.

    Banks borrow settlement balances from the Fed through repo using government securities as collateral.

    Banks borrow from the Fed through the discount window at the penalty rate.

    Banks also get settlement balances:

    When they take a deposit from a customer depositing a draft on another bank. Then the other banks settles in settlement balances and the bank’s account at the Fed is credited and the other bank’s is debited.

    When Treasury spends it directs the Fed to credit a private account. The Fed credits the account of the customer’s bank at the Fed and the customer’s bank credits the customers deposit account. The Fed creates a liability and that liability is an asset of the bank. The bank then credits the customer’s account with a liability that is as debt of the bank to the customer and the customer’s assets as loan to the bank. The bank has settlement balances in its account at the Fed that it will use to settle the account on withdrawal.

    In QE if the bank sells the Fed securities it owns it gets settlement balances in its despots account at the Fed that are deducted from its securities account at the Fed.

    So in summary, the bank gets settlement balance from borrowing from the Fed, from depositors and from other banks in the interbank system.

    • Tom, I’m still concerned with a debit recorded in the bank’s spreadsheet that the money in the deposit for the loan for the purchasing of the security has been withdrawn and transferred to a Treasury account at the bank (or wherever) . If the security has been purchased by the Fed with money it created out of thin air, then the security leaves the bank to the Fed, and the Fed puts the face value of the security in the bank’s ‘reserves’ (settlement balances). Does this money from the Fed not net to zero with the negative balance at the bank on the original paying of the Treasury for the security? That’s what I mean about the Fed’s money being ‘extinguished’. It just takes the security off the books of the bank in question and places it on the Fed’s books. But it would mean that the quantity of settlement balances at the banks should not be as big as they seem to be (or was that already figured into those figures in the graph you showed me?)

  31. stanislaus2

    But for monetary theory, banks still do create dollars and while they circulate they can contribute to inflation under certain circumstances. The housing bubble was a case off the Fed’s books, no?

  32. Tom, are you familiar with Paul Sheard’s essay “Repeat after me: Banks cannot and do not ‘Lend Out’ reserves”? http://www.standardandpoors.com/ratingsdirect.
    He uses a different terminology from you. Comments?

  33. “But for monetary theory, banks still do create dollars and while they circulate they can contribute to inflation under certain circumstances. The housing bubble was a case off the Fed’s books, no?”

    Right. Banks are agents of government to whom the function of credit management is delegated. It more efficient for agents make lending decisions and separates lending from the political process as well.

    So banks are allowed to denominate the deposits they create through loans in dollars and are granted access to the central bank for clearing. The central bank also acts as the lender of last resort to ensure sufficient liquidity in the payments system for all payments to clear.

    Government also guarantees deposits up to a certain limit.

    IN order to get there privileges, banks must agree to rules that government sets, including close supervision.

    Most of the spendable money supply M1 is deposit accounts and most of the funds in deposit accounts were created by banks making loans.

    Bank credit is much more likely to result in demand inflation that government spending, other than in unusual situations like war.

    Bank credit is also at the root of demand inflation that results in booms when credit is overly loose and busts when credit is tightened, often suddenly.

  34. “Tom, are you familiar with Paul Sheard’s essay “Repeat after me: Banks cannot and do not ‘Lend Out’ reserves”? http://www.standardandpoors.com/ratingsdirect.
    He uses a different terminology from you. Comments?”

    Read it when it came out. Nice piece.

    He uses the traditional term “reserves” for what I call “settlement balances,” others use “payments balances.” Same thing. “Reserves” is a holdover from the gold standard and technically doesn’t apply in a floating rate system. I and others avoid using it so as to discourage gold standard thinking, which is still pervasive and leads to confusion and error.

  35. “But whether the banks have gobs of dollars in their reserves or not does not matter, since in any case they cannot access those dollars for making loans, right?”

    Right. It is a misconception that settlement balances in banks’ accounts at the Fed influence banks lending. In the first place, banks don’t lend out settlement balances. Secondly, the concept of the money multiplier is wrong, as QE showed. The amount of settlement balances doesn’t influence lending.

    What happens in the lending process?

    A customer applies to the bank for a loan and the bank assigns a loan officer. The loan officer evaluates the creditworthiness of the applicant, the quality of the collateral and other assets that might count in recovery in case of default, and assesses the risk in arriving at an interest rate for the loan.

    The loan department alerts the asset & liability department about loans in process so that A&L can anticipate the settlement balances, since loans are made for a purpose and deposits created by loans are usually drawn upon quickly. Just as the bank seeks the mosts advantageous interest rate it can get on loans in a competitive environment, the bank also seeks the least expensive funding.

    Banks make their profit on the spread between what the loan for and what the borrow for. Bank fees for service and penalties are supplemental.

  36. “But for monetary theory, banks still do create dollars and while they circulate they can contribute to inflation under certain circumstances. The housing bubble was a case off the Fed’s books, no?”

    Banks made loans that should not have been made. They lent to people that were not able to repay and often where the bank would have discovered their problematic creditworthiness if they have done due diligence.

    Moreover, banks lent against overvalued collateral, often based on appraisals that were known to be inflated.

    The Fed’s books didn’t enter into it other than clearing checks drawn on bank deposits created by housing loans.

    However, the Fed did share responsibility as a regulator. Regulators were asleep at the switch as a matter of policy in an environment of deregulation. There was massive fraud that the FBI warned about and the Fed chair ignored.

  37. My view on the national debt is that it is held by three entities:

    (1) banks,

    Essentially correct. But I would not say that the Treasury “borrows money from banks.” The Treasury issue Treasuries to be sold at auction by the Fed. The principal participants are the primary dealers.

    FRBNY: “Primary dealers serve as trading counterparties of the New York Fed in its implementation of monetary policy. This role includes the obligations to: (i) participate consistently in open market operations to carry out U.S. monetary policy pursuant to the direction of the Federal Open Market Committee (FOMC); and (ii) provide the New York Fed’s trading desk with market information and analysis helpful in the formulation and implementation of monetary policy. Primary dealers are also required to participate in all auctions of U.S. government debt and to make reasonable markets for the New York Fed when it transacts on behalf of its foreign official account-holders.”

    http://www.newyorkfed.org/markets/primarydealers.html

    http://www.ny.frb.org/markets/pridealers_current.html

    The primary dealers then sell the securities they don’t want for their own inventory to other buyers.

    When a Treasury security matures, it is paid off from the Treasury account and another Treasury is auctioned off. The amount of Treasuries and settlement balances in the system is unchanged. This is how debt is rolled over.

    <The Treasury gets interest also by selling securities to banks.”

    The Treasury gets the interest from its settlement balance account. There are two principal sources of credits. Taxation and debt issuance.

    “This procedure makes the money obtained from the securities for all practical purposes debt-free, since a debt whose principal is never to be paid is not a real, ordinary debt. So, it doesn’t matter how large the accumulated principal is, piecemeal it is tractable, and in aggregate never to be paid.”

    Right. This is crucial. The national debt is not repaid for the simple reason that it is provided to investors as a safe asset for saving. Paying down the debt would require savers to save in riskier assets. This is why there is always a demand for Treasuries.

    • <The Treasury gets interest also by selling securities to banks.”

      The Treasury gets the interest from its settlement balance account. There are two principal sources of credits. Taxation and debt issuance.

      I presume that because the Treasury had to deficit spend, its source of tax revenues has been exhausted. So it would have to get the interest money from the Fed as a loan. Does it do this with a security to the Fed? Why can’t the Fed give the interest money to the banks or investors who ‘hold’ the security in question. Is there a way for the Treasury to receive this money for interest payments as an agent, custodian, who has no money interest in having the interest for its own use other than in paying the interest?

    • My view on the national debt is that it is held by three entities:

      (1) banks,

      Essentially correct. But I would not say that the Treasury “borrows money from banks.” The Treasury issue Treasuries to be sold at auction by the Fed. The principal participants are the primary dealers.

      I suspect that when the 1917 law required the Treasury to ‘borrow’ instead of just issue the US Treasury Notes with which to do the deficit spending, the banks wanted the lending to be distributed around in a fair way instead of just one private bank doing all the lending. Hence the use of the public auction. They wanted access to the interest to be spread around.

      But the banks hold the securities, do they not? So they are the lenders and creditors. The securities bought by the banks were bought from the banks by the Fed in QE.

      That the banks receive interest at maturity shows they are the lenders. Am I mistaken if I do not think the primary dealers get the interest? Whence comes the primary dealers’ fees for the transactions?

      I know, you do not want the banks themselves to be the origins of the money but the Fed, so you would not say the Treasury borrows money from banks. But whatever happens the banks must initiate the response to the Treasury for money. So the impulse of their money gets matched by the Fed as bank dollars are exchanged for Fed’s settlement balances. It is the exchange which makes for me at this point the equivalence of Fed settlement balances and bank money. Would the Fed reject the banks’ money? Without the banks to initiate the response to the request by the Treasury for money, there would be no money given to the Treasury for deficit spending. The law prevents Fed from giving money directly to the Treasury and the Treasury using its own money creation powers to create the money as well. Bank money is just part of the general dollar scheme.

      To me settlement balances as distinguished from bank dollars is an unnecessary distinction to make the government side believe it is
      the ultimate responsibility for the creation of money in our system. But it has no real independent function. I still remain open to further argument on your part, however. (I’m learning a lot from you.) This is sort of on the order of “How many angels can dance on the head of a pin?’

      Or the Fed gets the information to put the banks’ dollars in its spreadsheets.
      That alone, in my opinion, would be sufficient to give legitimacy to the dollars created by the banks for the purchase. I just can’t accept this idea of two kinds of dollars. It is easier to accept two sources of money creation but place legitimization at the government, which has the power to punish counterfeiting.

      I don’t see how we can require the banks to already have all the settlement balances to purchase the securities. You can’t first say that the banks must
      purchase the settlement balances from the Fed and then require that they already have the settlement balances before coming to the auction with which to make the purchase. And why the purchase of settlement balances?

      We have to accept the bank dollars created by them out of thin air make up a much greater portion of the money supply and that they pass seamlessly from banks to the Fed.

    • My view on the national debt is that it is held by three entities:

      (1) banks,

      Essentially correct. But I would not say that the Treasury “borrows money from banks.” The Treasury issue Treasuries to be sold at auction by the Fed. The principal participants are the primary dealers.

      Then why is Treasury Secretary Lew appearing before Congress to testify that the debt limit is inhibiting his borrowing money to pay not just new deficits but old debts?

  38. “(2) Investors also buy US Treasury securities with dollars they have accumulated. This money is never used to pay for the deficit spending of Congress, i.e. government operations. It is kept in time deposit accounts at the Fed. It is there to be returned to the investors on demand at maturity of the securities. These debts may be rolled over by issuing new securities and swapping them for the mature securities on the principal and paying interest on the mature securities.”

    Not quire right. The Treasury securities are part of the stock of debt that was created by the flow of deficit spending. Since those securities are generally rolled over they stay in place as part of the stock of debt.

    “So, the money is always there to pay back the investors in the time-deposit accounts at the Fed. No problem there.”

    The time deposit accounts at the Fed are the securities, which exist as entries on the Fed’s spreadsheet. As they mature, they are generally rolled over.

  39. “(3) The intragovernmental series securities cannot be bought directly by the Fed. But the Treasury can buy them if it has dollars. It can get these dollars as needed by borrowing from the banks using marketable securities. So, there is a way to buy these securities and redeem them. The Fed can buy the marketable securities used to raise this money with money it creates out of thin air. Then it will swap these securities for new securities with the Treasury which extinguishes the marketable securities used to raise the money for buying the intragovernmental securities. No debt problem either.”

    The intragovernmental holdings are accounting gimmicks that commit funds by program, e.g., Social Security trust fund, Medicare trust fund.

    As FICA taxes are collected, the settlement balances are credited to the Treasury General Account (TGA) for spending. The appropriate trust fund is credited with an intragovernmental obligation. When FICA receipts fall short of dedicated expenses, then the dedicated trust fund is debited.

    It’s just accounting entries to record the flows of funds from tax revenue to different types of expenses. It’s meaningless to non-government since these are just entries on the government’s books that record operations among agencies and programs.

    All the talk about the government trust funds being depleted is scare tactics based on the erroneous assumption that government needs to get money from the private sector when the government is actually the currency issuer.

  40. “clearing their books of these loans by selling them to the Fed” is correct.

    The Fed gets an assets, the loan, and the bank gets an asset in the from of settlement balances, which the Fed creates as a liability.

    Fed asset: loan
    Fed liability: settlement balances credited to seller

    Bank asset: loan account debited
    Bank asset: settlement balance account credited

    The borrower now owes the outstanding P & I of the loan to the Fed instead of the bank.

  41. “How does the auction know whether the bank’s money comes from previously acquired settlement balances or the banks creation of the money?
    Suppose it is a mixture of both kinds of dollars…”

    Banks can’t create settlement balances. Only the Fed can and they reside as entires on the Fed’s spreadsheet that only the Fed can keystroke. Auctions settle in the payments system in settlement balances.

    When banks credit deposit accounts it promises to settle in either cash or settlement balances at the Fed, which means that the bank need to obtain cash or settlement balances that are only created by government.

    This is the hierarchy of money. in descending order.
    Currency
    Bank credit
    Non-bank credit.

    What just happened in Greece is that the ECB refused to supply settlement balances and the Greek banking system froze up. People have funds in their accounts but can’t access them because the banks can’t settle for lack of liquidity in the payments system.

    Banks get settlement balances from the Fed crediting their accounts at the Fed as a result of government spending, or they borrow settlement balances when they need them through other banks that have an excess of them, or from the Fed.

    “Dollar” is the unit of account in the dollar zone which by the way is larger than the US. It’s everyone that uses dollars. There are different forms that the dollar takes. One obvious difference is dollar bills used for spot transactions and check drawn on banks that represent entries on a bank’s books. Another is the settlement balances at the Fed that the bank may need to use to clear a customer’s check drawn on a deposit account at the bank that is presented in the payments system by another bank, or else to pay taxes.

    • When banks credit deposit accounts it promises to settle in either cash or settlement balances at the Fed, which means that the bank need to obtain cash or settlement balances that are only created by government.

      Considering the size of federal deficits, where does the bank get these settlement balances (reserve balances)? From other banks or borrow from the Fed? If so, why does the bank believe it will be able to pay back these debts? They are rather big, no?

      This is the hierarchy of money. in descending order.
      Currency
      Bank credit
      Non-bank credit.

      I think you said elsewhere that settlement balances were currency. Do you mean coin, paper bills? If that is all, then an awful lot of armored cars are going to be needed to haul this around to the bank and then to the auction.
      So, clarify what currency is.

  42. “I would rather see the auction accepting any dollars created by the bank or acquired by the bank and converting these by making them settlement balances….”

    Then government would lose control of its currency. Not going to happen.

  43. is there some special reason for having banks purchase these settlement balances to be able to purchase the securities?

    The hierarchy of money gives the government control of the currency per US Constitution, Article 1, section 8.

    The Federal Reserve Act establishes the relationship of banks with government as public/private partnerships. Banks are essentially franchises of government. They are privately owned but are agents of the government, unlike government agencies which are part of government

    “But you say banks can’t buy securities from the Treasury with just any ordinary dollars. That means the banks can’t essentially create money out of thin air to buy these securities. The banks must have acquired the special money for this buying previously. ”

    Right. Just like banks can’t print currency but have to obtain it from government. Otherwise it is counterfeiting.

    “To me this puts ultimately a limitation on the banks providing funds for purchasing US Treasuries. It suggests that there may be at some point an upper limit to the amount of money that the banks can come up with to buy these securities with. This doesn’t sound like the freedom we preach to be able to pay any deficit that may arise in our doctrine on fiat money.”

    Government creates currency out of thin air to to transfer private resources to public use through government purchases. This creates the settlement balances with with the securities are purchased.

    “And it would actually make the Treasury’s method of paying interest a Ponzi scheme when at some point no bank can lend the Treasury to buy its offering of securities.”

    A government that is a currency issuer doesn’t need to get money from anywhere. It issues currency from thin air by keystroking entries into the central bank’s spreadsheet.

    • “But you say banks can’t buy securities from the Treasury with just any ordinary dollars. That means the banks can’t essentially create money out of thin air to buy these securities. The banks must have acquired the special money for this buying previously.

      Right. Just like banks can’t print currency but have to obtain it from government. Otherwise it is counterfeiting.

      Then what about banks making loans for mortgages, or credit cards, or car purchases, business loans….
      Are those counterfeiting?

      The law requiring the Treasury to borrow to cover deficits is an effort initiated by bankers who wanted to earn interest on the government’s creation of money. So, they see the money they create as being lent to the Treasury.

      What concerns me is that MMT is downplaying the role of banks in money creation. Ignoring the role of the banks in creating debt led to the neoclassical economists to fail to see that the bubble in the housing market generated by the banks making loans was going to bring the economy down when it burst.

      If banks can make money on their own by creating loans to private citizens they should be able to do the same thing for the government in generating money for purchase of securities. If the Fed wishes to replace their money with money on its spreadsheets by converting the bank dollars to settlement balances that is one thing. But the banks initiate the response for loans and decide how much to bid for the securities.

      Comment?

      • Wray’s Modern Monetary Theory, pp. 106-107 gives some but not sufficient information to fully understand it, so much is just hand waving:
        Wray says:
        “A. The Fed undertakes repurchase agreement operations with primary dealers (in which the Fed purchases Treasury securities from primary dealers with a promise to buy them back on a specific date) to ensure sufficient reserve balances are circulating for settlement of the Treasury’s auction (which will debit reserve balances in bank accounts as the Treasury’s account is credited) while also achieving the Fed’s target rate…:
        On further reading, I note that he is saying that the Fed first purchases the T securities from the primary dealers [who?] promise to buy them back on a specific date) to ensure sufficient reserve balances are circulating for settlement of the Treasury’s auction etc.)

        (Reading that as the Fed promising to buy back what it already has bought makes no sense).

        But this raises the question: How did the primary dealers get the securities in the first place? What money did they use? Or did the Treasury just give them to the dealers to sell? If so, then the next action seems illegal because it is Fed buying securities from the Treasury with the dealers just acting as agents for Treasury in this sale. (So I will presume that the dealers bought the securities from the Treasury with someone’s settlement dollars.

        But then, Why does the Fed need then to buy them from the dealers before the auction? (I can’t find any description of this in the internet. Can someone supply reference to such a description to back up Wray’s account? Fed does buy securities in OMO, but the repros are something else and not well documented). Evidently the dealers may be getting funds from client banks to buy these securities and the dealers must be supplied with settlement balances from the Fed with which to buy them back (for the client banks).

        So, later after it is decided who wins the auction, the dealers buy the securities from the Fed, using the settlement balances they got from the Fed. But now how will the the Fed’s action have any effect on the subsequent action of the dealers turning around and selling the securities to the client banks? The settlement balances have been returned to the Fed for the securities.

        My speculation: The client banks must produce dollars with which to buy the securities they won in the auction from the dealers. How do they get enough settlement balances to buy them? Could they get them any other way by Fed’s lending or exchanging currency, say, for loan account bank dollars. Or could the primary dealers have enough settlement balances to allow the banks to purchase these with their bank dollars from the loan?
        (Please provide documentation describing that this occurs).

  44. “Are there documents to read about these settlement balance dollars you refer to?”

    See the following. Scott T. Fullwiler, Modern Central Bank Operations – The General Principles

    Scott calls them “reserve balances.” Sometimes this is abbreviated as “rb”. “Settlement balances,” “payment balances” and “reserve balances” mean the same thing.

    Bank reserves = rb + vault cash.

    Bank reserves are not part of M1 money supply, which is bank deposits + cash in circulation and other liquid financial assets like NOW accounts.

    • Scott’s essay does not provide the details of the public auction for sale of Treasury securities for funding of deficit spending by the govt. There is too much ‘hand waving’ in these accounts. And the institutions (Fed and Treasury) seem not to provide enough detailed information to know exactly what is going on.

  45. “For some reason I thought each bank’s spreadsheets were copied and kept at the Fed as the bank’s reserves. Today, with computers this seems plausible. It would be a way for the Fed to know and record as settlement balances certain purchases of securities by banks, among other things.

    No, bank reserves are the settlement balances on the Fed’s spreadsheet plus vault cash, that is, cash held by the bank that has not passed into circulation.

    Banks’ books are inspected on a regular basis by bank regulators.

  46. “Eventually the Fed will swap these mature securities it got from the banks for new securities from Treasury. When the Treasury receives the mature securities, they have returned to the issuer, and being mature, cannot be discounted and thus sold. Thus they are extinguished or locked up in some deep vault somewhere. That’s where and when the debt of the securities gets completely extinguished.”

    You are thinking of securities as pieces of paper. They are loans in the accounting sense and reside on someone’s balance sheet as assets and someone else’s balance sheet as liabilities. When the loan is repaid the asset and liability cancel each other.

    What happen when a government security matures is that the Fed shifts the credit to a securities account to a settlement balance account. That’s it. What happens is the the Treasury pays of a loan (liability) with settlement balances (asset) and the power of the security gets a debit to securities and a credit settlement balances, both asset accounts. The owner of the matured security now has principal + interest in settlement balances.

    If the security is rolled over by the same entity then the settlement balances are used to purchase a new security. It’s like when a CD comes due and the customer just transfers the funds to another CD at the bank. The settlement balance account is marked down and the securities account is marked up. It’s a transfer of asset type but not amount.

    Securities can also be rolled over among different entities. The securities are purchased out of the aggregate settlement balances in the system, which have been increased by the maturing securities. Then some other entity buys a security using settlement balances.

    Again, it’s much simper to think in terms of sectors since huge sums are involved every day in the Treasury market, most of which is just portfolio shifting that takes place within the same sector. All accounting records have to balance internally and with each other, both among entities and sectors where the books of the entities making up the sector are consolidated. So one can tell what happened overall in terms of stocks and flows in the various sectors without having to deal with the myriad entities.

    government — non-government

    government — Treasury + central bank

    non-government — banks + non-banks

    banks — consolidate into a single banking system as one bank

    non-bank entities — consolidate into domestic private sector and external sector

    domestic private sector — household sector + commercial sector

  47. “So instead of giving the investors their securities they are kept at the Fed in time-deposit accounts in lieu of the “cash” or money used to buy the securities. That saves distinct places for securities and purchase money by merging them into one “record” the securities (as entries also on a spread sheet?). But the point is that these securities are kept in time deposits and the Fed can “expand” them into settlement dollars (?) on demand at maturity by recreating them out of thin air. What happened to the original investor dollars used to purchase the securities. Was it just ‘absorbed’ into the securities, then stored for the investors in time-deposit accounts. It’s all the same money.”

    It’s essentially the same as switching between a demand deposit account at a bank and a time deposit account to earn more interest. The difference is that government securities are negotiable instruments that are highly liquid and not much different from cash. Corporations hold their “cash” deposits in the from of T-bills.

    A non-bank entity like a corporation wished to save in “cash.” So it makes a deposit in a bank using a check drawn on another bank. The corporation’s bank clears the check in the settlement system and the bank of the writer of the check transfers settlement balances to the account of the corporation’s bank. The writer of the check’s deposit account is debited and the corporation’s deposit account is credited. Then the corporation directs the bank to buy T-bills. The corporation debits the corporation’s deposit account and purchases the T-bills with settlement balances. The T-bills are then held in the bank’s Fed account as broker and the corporation’s securities account is credited at the bank.

    This is all done by moving entries around on spreadsheets. It used to be done with pieces of paper but that’s pretty much long gone owing to the transaction expenses. Digital transactions are almost costless and they are instantaneous. You can conceptualize it as moving tokens around to make it concrete but that’s not what happens anymore, just like hardly anyone uses cash for spot transactions now but rather credit cards.

    “What happened to the original investor dollars used to purchase the securities. Was it just ‘absorbed’ into the securities, then stored for the investors in time-deposit accounts.”

    Conceptualizing it with tokens, the purchaser deposits cash in the bank. The bank converts the cash to settlement balances and uses the settlement balances to purchase T-bills and then delivers the T-bills to the customer. The customer now has T-bills instead of dollar bills and the banks has entries on its books that cancel each other. What happens now is the essentially the same thing using entires on spreadsheets instead of using tokens.

  48. Senexx here. I’m not logged in. I’ve only given this a skim but I think Stan is more asking about the pyramid hierarchy of money as best as I can tell – how all monies regardless of where creation begins is settled at par with government created money

  49. “Senexx here. I’m not logged in. I’ve only given this a skim but I think Stan is more asking about the pyramid hierarchy of money as best as I can tell – how all monies regardless of where creation begins is settled at par with government created money”

    That’s what I have been trying to tell him. 🙂

  50. “I presume that because the Treasury had to deficit spend, its source of tax revenues has been exhausted. So it would have to get the interest money from the Fed as a loan. Does it do this with a security to the Fed?”

    Not in the US. The Fed cannot loan funds to the Treasury. The Treasury has to get settlement balances by going through the loop of the private sector because it looks like Treasury is getting the funding from the private sector when that can’t be the case since non-government doesn’t issue currency, only creates credit.

    So when taxes are paid using bank credit, the bank has to get the settlement balances that only come from government to settle and this comes only from government spending or lending.

    If the settlement balances that get credited to the Treasury account are insufficient to meet expenses, then Treasury has to issue securities that sold by the Fed at auction and paid for with settlement balances. Again, if a purchaser uses bank credit to purchase securities, then the bank has to obtain the settlement balances to settle in the payments system.

    For example, the Fed sells securities at auction to the primary dealers. The primary dealers can borrow the settlement balances from the Fed using repo from their existing securities inventory to get the settlement balances to pay for the auction. Then they sell the securities on and use the settlement balances they receive from the sale to repay what they borrowed from the Fed. If it sounds like a shell game, it is.

    “Why can’t the Fed give the interest money to the banks or investors who ‘hold’ the security in question. Is there a way for the Treasury to receive this money for interest payments as an agent, custodian, who has no money interest in having the interest for its own use other than in paying the interest?”

    The Treasury is responsible for paying interest on its securities. It does this by directing the Fed to credit bank accounts using settlement balances from the Treasury account. Interest payments are on budget as government spending.

    • “I presume that because the Treasury had to deficit spend, its source of tax revenues has been exhausted. So it would have to get the interest money from the Fed as a loan. Does it do this with a security to the Fed?”

      Not in the US. The Fed cannot loan funds to the Treasury. The Treasury has to get settlement balances by going through the loop of the private sector because it looks like Treasury is getting the funding from the private sector when that can’t be the case since non-government doesn’t issue currency, only creates credit.

      So, the banks are a necessary evil here, no?

      You know there have been long periods of time in the history of our nation when there was no central bank, and banks created the money supply.
      And Lincoln’s greenbacks cut out the banks from money creation for the government, without there being a central bank. We got the Fed in 1913 and then the banks got the Treasury to have to borrow from them to pay off a deficit of Congress.

      So, MMT is trying to make sense of our system as a fiat system under monopoly control of the central government (not just the Fed). I accept your idea that the Federal Reserve BankS are franchises representing a joint operation of federal government and private banks to control the banking system.

      I’m willing to go along for awhile on MMT’s treatment of our system as a monopoly of the government. But the role of the banks needs to be given greater emphasis. If the Fed can get by law the right to create money out of thin air, the banks should also when they make loans, although banks create debt to borrowers, while the Fed gives them credit with no strings attached when it buys securities. Otherwise thinking the banks are counterfeiting with money creation when they try to make loans they create to buy securities strikes me as a tear in the fabric of MMT’s account of how these two systems of government and private banking are merged. The merger should be more seamless.

      And I am open to changing my views if there are good arguments to the contrary.

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