BLOG #10 RESPONSES: ACCOUNTING FOR MONEY FLOWS

L. RANDALL WRAY

Thanks for comments. I am cutting off the responses early, and will keep this short, because I am in Euroland and preparing to fly back.

Let me quickly respond to the six people who commented, and then provide a short answer to the homework question.

Neil: One imposed constraint is that banks can refuse instructions to make transfers, including transfers ordered by government that has abandoned its fiat money.

Answer: OK for individuals the bank might refuse in two cases: apparent fraud or insufficient funds. We certainly applaud any bank that refuses to shift funds out of our account if it suspects fraud! We are not quite so happy when it refuses to clear a check in the case of an overdraft, because we get charged fees. But, OK, so far. In the case of government, I’m not quite so willing to go along with your suggestion, for two reasons. First, I do not really like the term fiat money and do not know what it is supposed to mean. I use the term sovereign currency. As I will discuss in coming weeks, there are different sovereign currency regimes—from fixed to floating rates. A sovereign’s currency is, on my definition, sovereign. There are constraints on sovereign spending, including those self imposed. It could instruct its bank (the central bank) NOT to make payments when its deposits are insufficient. It might even instruct the CB to impose fees for insufficient funds! Beyond that I am not quite sure what point you are making. Even if the sovereign government did not have a “fiat currency” (whatever that means) it could decapitate any central bankers that bounced checks. This might become more clear soon.

Had ‘Nuff: Money of account can be replaced by medium of exchange; domestic currency should include demand deposits; government IOUs are not debt; currency tax.
Answer: Think of it this way: Money of account is the measure (foot, yard, inch), medium of exchange is the thing being measured (shoe, arm, earlobe). Domestic currency is the government’s IOU; demand deposits are bank IOUs—so in my view we should not mix them. They are issued by quite different entities. An IOU is a debt, so government IOUs are debts. Not sure what point you are trying to make. 
Now, why would I disagree with JKH, who claims reserves should not be included in a definition of currency? Reserves, Federal Reserve Notes (our green paper money), Treasury notes (yes, Treasury has issued paper money, too), and Treasury coins are all IOUs issued by government (either Fed or Treasury), and all commit Uncle Sam. Fed losses come out of the Treasury. If Fed goes insolvent (which it might!), Treasury will cover the losses and recapitalize it.

Functionally there is one difference in that Reserves can only be held by banks; the rest can be held by you and me. But reserves are perfectly substitutable for all the others. So why do some resist recognizing this? They want to maintain the fiction that the Fed is not part of government. Sorry, Charley, it is. Plain and simple, it is a legal creature of Congress. Finally, I have no idea what a currency tax is.

James: Treasury’s account at the Fed is not counted as money supply but rather is a Fed IOU; but Treasury spending reduces its deposit at the Fed thus taxes do “pay for” Treasury spending.

Answer: Well, I do not see how. When you pay your taxes, you draw down your bank demand deposit. A private bank credits the Treasury’s account at the bank. BUT THE TREASURY CANNOT WRITE A CHECK ON THAT. There is no way the Treasury can “spend” your tax payment. It can only write checks on its account at the Fed, and you do not have an account at the Fed. You cannot deliver to the Treasury what it needs to spend. You might say I am being picky. I say I am being precise.

Hepion: Banks keep their money at the Fed; where does the Fed store it; and who manufactures it?

Answer: The Fed hides it in caves in Kansas City. Send a self-addressed and stamped envelope with $5000 in unmarked bills to me, and I will send you a secret treasure map with an X marking the spot.

Seriously: banks don’t keep money at the Fed, indeed, banks do not have any money. Willie Sutton (google him) was wrong. Don’t bother robbing banks, because that is NOT where the money is. Banks have an electronic account at the Fed—numbers on a harddrive. I suppose the harddrive is made in China. No other manufacturing is involved. In addition, banks have a very small amount of “vault cash” in their vaults. Believe me, not worth robbing. If you really want to rob banks, do what my colleague Bill Black says: the best way to rob a bank is to own one. Then you simply credit your own bank account with bonuses. Where will you get the millions of dollars to credit your account once you own a bank? Keystrokes.

Marley: How does Fed buy back Treasuries?

Answer: You are well on your way to getting this right. Fed credits private bank (selling the Treasuries) with Fed’s own IOU, bank reserves. Fed holds the bonds as assets, offset by reserves as liabilities. So in the end, although Fed cannot buy the bonds directly from the Treasury, it buys them from banks.

Adam: (Long post…I won’t repeat it)

Answer: By Jove, he’s got it! Excellent. Grade = A.

Homework Assignment: where does the electronic “scoreboard” money come from or go to? Think of the football game, or bowling. Where do the points “come from” when you score a touchdown or knock down a pin? Where do they go at the end of the game when we clear the score board? Well, they are just “key strokes”—electronic pulses that light up the LED when points are scored, and we stop sending the pulses to turn off the LEDs. That’s all there is to it. Keystrokes.

Follow up homework? Can Government run out of keystrokes?

15 Responses to BLOG #10 RESPONSES: ACCOUNTING FOR MONEY FLOWS

  1. R,Thanks again for your time mulling my musings. do appreciate it.One of the things we need to get sorted out is the terms. It's the key to understanding amongst the different models.Otherwise you spend half the time providing the definitions.In this context I'm using the term Fiat Money to cover what MMT calls vertical transactions between Issuer and Users and Credit Money to cover horizontal transactions between Users and Users.(The Capital Letters is a trick lawyers use to show that the term is a special defined term and not a dictionary defined term. I recommend it as an approach.And I know the term Money is distasteful – I can't think of a better term that covers more than just the currency. Suggestions welcome!).My point is that in the case of a normal User there is usually a third party that can stop payment independently of the desires of the User. The instructions of a company to a bank will be stopped by the bank eventually – on the say so of the bank alone. And that decision will be backed up by the legal system. The User has no comeback against the bank and must accept their fate.Practically it's more difficult when the bank is taking instructions from part of the government. If a bureaucrat refuses a direct instruction from an elected representative of the people (even when relying on previous instructions) then it causes a crisis that generally results in the rules being changed rather than the instruction being stopped.So it comes back to the fiction that the government's bank is 'independent'. Unless it can appeal to a higher authority (such as the European courts in the case of a European Union member), then it can't really say 'no' independently.

  2. I don’t recall saying that reserves shouldn’t be included in the definition of currency, although I may have implied it. I don’t think I’ve made an issue of the definition.What I have said is that within the usual definitions that compose the “monetary base”, reserves and central bank notes should be viewed far differently for monetary policy purposes. The functional difference is more than just the fact that commercial banks hold central bank reserves. It’s that central banks determine the supply of and set the price for reserves for monetary policy purposes – whereas they are passive suppliers of central bank notes according to public demand. This difference is unrelated to how one views the position of the Fed in government.

  3. So you said that when the government collects its taxes by debiting a bank account, then the reserves of that bank will be debited by the amount taxed. What about transactions in the private sector? If person A gives a check of 100$ to person B, will person B's bank receive a credit of 100$ of reserves from person A's bank? Because reserves from my understanding, are the way a government tracks currency.

  4. Thank you Dr. Wray. That was the missing piece. Sorted.

  5. Currency tax:http://www.itulip.com/Select/feddeflationplaybook.pdfFrom the Federal Reserve Bank of Dallas"Bold, but impractical–eliminating the bound altogetherThe most daring suggestion for escaping the zero-interest-rate trap is one that eliminatesthe zero lower bound altogether. How can this be done? As noted in the first part of thepresentation, the zero bound on interest rates exists because money pays a sure nominalinterest rate of zero. No one would be willing to hold any asset that pays a negative nominalrate, as long as zero-interest money is available as a store of value.The strategy for eliminating the zero bound, therefore, is to make money pay a negativenominal interest rate, by imposing some type of ‘carry tax’ on currency and deposits.It’s easy to envision such a system with regard to deposits at the Federal Reserve ortransactions deposits at banks; for the most part, the technology to implement such asystem is already in place. A tax or fee on Reserve deposits of 1% per month, for example,would mean that those deposits, in effect, pay a nominal interest rate of roughly minus12%.The technological difficulty lies mainly in imposing such a tax oncurrency. In the 1930s, Irving Fisher of Yale University, one of thegreatest American economists, proposed such a system, in whichcurrency had to be periodically ‘stamped’, for a fee, in order to retainits status as legal tender. The stamp fee could be calibrated togenerate any negative nominal interest rate that the central bankdesired.While the technology available for implementing such a system ismore sophisticated today than in Fisher’s time, enforcement still seems a mammothproblem, involving physical modifications to currency and some means of tracking thelength of time each piece spends in circulation.Given the technological hurdles involved in its implementation, a carry tax on money maynot be feasible as a response to any events that might transpire in the next year, though itcertainly merits study as a possible response to events that might transpire in the nextdecade. This is particularly the case if achieving and maintaining price stability makesbumping up against the zero interest rate bound a more frequent event.I'll think about the other responses.

  6. Dr Wray – Thank you for your reply. I appreciate the opportunity interact with one of the leading proponents of MMT. I have no substantial background in economics but in trying to understand our monetary system I have gravitated to MMT because it makes sense to me.However, in regard to the issue of taxes financing spending I am still unclear. The context is this: some MMT literature for the lay public states that taxes destroy money. At first I thought this meant that taxes taxes are removed from the money supply. I understand this is true in the sense the the Treasury account at the Fed is not counted as being part of the money supply. It seems that a large part of the daily activity of the Treasury and Fed has to do with managing the Treasury's balance at the Fed and coordinating calls to TTL accounts, etc. in order to cover Treasury spending. So, you have taxes in the TTL accounts on the one hand and Treasury spending on the other hand and frantic activity in the middle to manage reserve flows. From a distance it sure looks like taxes are being used to finance spending. I realize that the spending comes first and that the taxes are ticked off after the fact. Any overdraft is covered by selling bonds. Is this what you mean when you say that the Treasury cannot write a check based on the TTL accounts – that the spending comes first and the comparing it to tax receipts comes after the fact?

  7. Dr Wray, about your question "Can Government run out of keystrokes?". I think that physically speaking there is no limit on the "number of keystrokes". However, I suspect there is a maximum number of keystrokes (at any given time) after which the procedure becomes inflationary. I read about your idea of a public debt without limits, and I am trying to understand it. However, when I think I fully understand it then I have the question: if a nation can expand the public debt indefinitely, then could you explain me the mechanics of Zimbabwe 2008, Weimar 1923, Hungary 1946, Yugoslavia 1994? Is there a limit on the number of keystrokes or not?I read somewhere that the limit of 'keystrokes' is given by the total amount of wealth all people in the nation are willing to go without. For example, suppose I COULD afford having 4 cars and 10 televisions, but actually I need only 2 cars and 1 television. The 2 extra cars and the 9 extra televisions I can live without are exactly the amount of money I am willing to accept. Repeat this argument for each taxpayer in the nation, add all the factor, the result (measured in dollars) should be the maximum amount of money in circulation. That should give a limit on the "number of keystrokes".Am I right?

  8. @Ankur: I think the answer to your question is in the original MMP#10 post." While working, the employee earns a flow of wages denominated in a money of account accumulating a monetary claim on the employer. On payday, the employer eliminates the obligation by providing a paycheck that is a liability of the employer’s bank. Again, that is denominated in the national money of account."If desired, the worker can cash the check at her bank, receiving the government’s currency—again an IOU, but this time a debt of the government. Alternatively, the check can be deposited in the worker’s bank, leaving the worker with an IOU of her bank, denominated in the money of account."The private sector transactions can be seen as a set of intrabank IOU's. Reserves don't get drawn down or credited unless a Fed/Treasury IOU is being redeemed/issued. Note the case of the worker "cashing the check", essentially causing a Fed IOU (currency) to be issued.

  9. Homework: Can Government run out of keystrokes?Well technically, no. If you subscribe to the paradigm that it's no different than scores in a game, then no.However, the question this brings up is:What are the consequences of "running up the score"? There have certainly been enough discussions around the "Quantity Theory of Money" here and elsewhere. I do take the position that "running up the score" does not necessarily increase "inflation". Nor do I believe it necessarily sets a course toward "Zimbabwe". At this link:http://bilbo.economicoutlook.net/blog/?p=3773I found a really good (IMHO) explanation of why "Zimbabwe" (happened in Zimbabwe and) shouldn't happen in the US.The way I understand it based on MMT is so long as we're running up the score on non-excess (as in there is a demand) goods and services, and moving toward full employment, then we're in the good.

  10. I understand that only the government can add in new reserves, and only the government can take reserves out through taxes. But,I'm still not understanding the movement of reserves (except for the interbank exchange). I don't know if this is another outdated concept, but from what I understand, banks keep reserves to clear their liabilities (demand deposits), so if a depositor needs to withdraw money- whether that's to pay someone else, or for their own use- a bank needs sufficient reserves to give the depositor the money they need- do the banks reserves get marked down whenever someone withdraws money from their demand deposit? Is the interbank exchange the ONLY way for reserves to move between private banks? Thank you for responding!

  11. @Ankur: I think anytime you "withdraw money", as in "receive currency", the reserves of a bank are drawn down.Check the information here:http://www.frbsf.org/publications/federalreserve/fedinbrief/services.html"When people need additional cash, such as during the holidays or at times of natural disaster or crisis, a depository institution may order more currency and coin from its local Federal Reserve Bank or Branch. Each institution pays for these orders by drawing down its reserve account balances held with the Federal Reserve."There is also a brief explanation of check processing that the Fed does which provides additional context to my previous answer.

  12. @Ankur: If by "withdraw money", you mean "obtain cash", then the answer is yes.

  13. "Domestic currency is the government’s IOU; demand deposits are bank IOUs—so in my view we should not mix them. They are issued by quite different entities."But out in the real economy they are mixed with both being medium of exchange. Are they issued by different entities? Yes. The better questions are how are they similar and how are they different."An IOU is a debt, so government IOUs are debts. Not sure what point you are trying to make."I think we might have different definitions of IOU. IMO, there are differences between 1-to-1 swapping and going into debt."Now, why would I disagree with JKH, who claims reserves should not be included in a definition of currency? Reserves, Federal Reserve Notes (our green paper money), Treasury notes (yes, Treasury has issued paper money, too), and Treasury coins are all IOUs issued by government (either Fed or Treasury), and all commit Uncle Sam. Fed losses come out of the Treasury. If Fed goes insolvent (which it might!), Treasury will cover the losses and recapitalize it. Functionally there is one difference in that Reserves can only be held by banks; the rest can be held by you and me."OK. Starting to get somewhere. There is a difference between central bank reserves and currency along with demand deposits. I still believe you should use medium of exchange (currency plus demand deposits) because that is what circulates in the real economy and both can be accepted as payment for taxes. How about going over currency vs. central bank reserves vs. demand deposits?I see no reason to bailout the fed if it goes insolvent. Goodbye and good riddance!!!

  14. JKH said: "What I have said is that within the usual definitions that compose the “monetary base”, reserves and central bank notes should be viewed far differently for monetary policy purposes. The functional difference is more than just the fact that commercial banks hold central bank reserves. It’s that central banks determine the supply of and set the price for reserves for monetary policy purposes – whereas they are passive suppliers of central bank notes according to public demand."If I'm reading that correctly and the way the system is set up now, I agree.

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