DIAGRAMS & DOLLARS: modern money illustrated (Part 2)

By J.D. Alt

5. TREASURY BONDS—Are they really what we think they are?

Recall that in the old diagram we started out with—the one Congress seems to be using as a guide for its budgeting process—Treasury Bonds appear to be the mechanism by which the Federal  Government “borrows” Dollars from the PS pot. Since we now understand that a Dollar is actually the Federal Government’s I.O.U. for tax credits, we can also see that it is illogical for the Federal Government to “borrow” these I.O.U.s. Why would it “borrow” its own I.O.U.—something it can instantly create any time it wants by simply saying, “I Owe You”? If that is the case, why does the FG “sell” Treasury Bonds?

Treasury Bonds play a big role in the Central Bank’s regulation of the Private Sector banking system, and also in the complex and arcane “method” by which the U.S. Treasury “spends” Dollars—but, for the purposes of our Diagram, we don’t need to deal with such trivia. All we need to understand is that, in fact, the Federal Government doesn’t really “sell” Treasury Bonds at all. To see this, we only need to review something we’re already familiar with: our own Bank Accounts.

As we know, there are basically two kinds of bank accounts: one kind of account we can withdraw Dollars from at any time, “on demand.” We can write a check, or we can find an ATM machine and exchange the “numbers” in our account for real Dollar Bills. As a general rule, banks pay us ZERO interest on these “demand” accounts. (In fact, they usually charge fees for our various transactions.)

The other kind of bank account is one which requires that we DO NOT remove our money for a specified period of time. These accounts are often called “certificates of deposit” or CDs. In exchange for our agreeing not to withdraw our money from the CD, the bank pays us interest. This arrangement is sometimes referred to as the bank “selling” us the CD, but everyone who has ever “bought” a CD knows that what is really happening is not the buying or selling of anything at all. Instead, we are simply taking some of the money out of our checking account (which doesn’t pay interest) and transferring it to another account (the CD) which does pay interest.

This, in fact, is exactly what is happening when the Federal Government “sells” a Treasury Bond. U.S. Dollars—whether they reside in a bank account or a wallet—do not pay interest. When a bank (or business, or person) “buys” a Treasury Bond from the FG, that bank or business or person is simply transferring some its financial wealth from Dollars (which pay no interest) into a Treasury Bond “account” which does pay interest. And the agreement is exactly the same as with the CD: In exchange for receiving the interest, you agree to leave your money in the Treasury Bond “account” for a specified period of time.

Viewed from this perspective, it is easy to see that one of the important consequences of the Federal Government “selling” Treasury Bonds is that a great number of Dollars are, in effect, “removed” from the PS pot! With this information, we can now add the second set of plumbing features to our new Diagram:

We have added a “Treasury Bond Account Chamber” which holds the Dollars that have been transferred into Treasury Bond “accounts” for a period of time. We have also added an “INTEREST” spigot to the FG pot—the Dollars paid as interest on the Bonds flows from this spigot into the PS pot. We can see that this plumbing arrangement, in effect, prevents a very large number of Dollars from chasing goods and services in the Private Sector economy—something that would push up prices (inflation)—and replaces those Dollars with a much smaller purchasing power (the interest payments.)

So our diagram now has two effective mechanisms for preventing the FG spending spigot from filling up the PS pot with Dollars to the point of overflowing (another way to visualize “inflation”—which we will now keep diligent track of with our “Inflation Meter”.) Theoretically, for a given amount of Sovereign Spending, we should be able to adjust the draining operations of Taxes and Bonds to keep prices under control.

It is worth noting that the “Treasury Bond Account Chamber” is also a very pleasing feature for citizens and businesses who happen to have a lot of excess Dollars. They are pleased because they can now trade their excess Dollars (which earn zero interest) for Treasury Bond “accounts” which provide them with a steady income that requires very little effort to “earn”.

6. QUESTION: Is the FG really a “Pot”?

One of the most striking features of the diagram we now have is that there are no Dollars flowing INTO the FG pot! Dollars flow out of the spending and interest spigots into the PS pot; Dollars drain out of the PS pot in taxes; and Dollars move back and forth from the PS Pot to the “Treasury Bond Account Chamber”. But the diagram shows no Dollars ever flowing into the FG pot. How can that be?

We already know the answer: A Dollar that flows into the FG pot can serve no logical purpose. The Federal Government doesn’t need that Dollar in order to have a Dollar to spend. For the sovereign to collect I.O.U.s to itself makes no sense. What we have been calling the FG “pot”, then, is not really a “pot” at all in the sense that something can be added to it—and we should modify our diagram slightly to avoid this potential confusion:

The FG “pot” has now been replaced with a “Sovereign Currency Issuer”. The SCI has only one function: to issue sovereign U.S. Dollars. You don’t have to put anything in the SCI (except paper, ink, and electricity to run the computer keyboards) to get Dollars out of its spigots. And this “machine” works—Dollars flow out of it as the Federal Government spends them—because we, the citizens, have agreed to the proposition that if we don’t pay our taxes with the Dollars the SCI produces, the FG then has the proper authority to put us in jail. At heart, it’s really a very simple (but dynamic) proposition.

7. The Most Amazing Coincidence

Let’s take a closer look at what is actually the most remarkable aspect of the diagram we now have before us—that is, the Sovereign Spending which flows out of the FG spigot. We now understand this Sovereign Spending is necessary to get U.S. Dollars into the PS pot where entrepreneurs and businesses then leverage them with bank loans to create goods and services, jobs and careers. What is amazing to contemplate, however, is that the initial Sovereign Spending of these Dollars also accomplishes something else: it creates goods and services that we benefit from collectively as a society—in many cases, that we benefit from substantially (as in: we might not even be alive without them.) In other words, the thing that drives our fiscal-monetary system coincidentally also makes it possible for us to build and create goods and services that make us collectively healthy and prosperous. The implications of this dynamic coincidence—when you actually “see” it—are astonishing, to say the least.

It’s important, then, that our new diagram somehow makes this most fortunate coincidence visible. I’d like to draw weather and GPS satellites, next-generation air-traffic control towers, fuel-cell powered bullet trains connecting city-center to city-center across the country, neighborhood health clinics, Home-Care providers in fleets of mini-vans filled with medicines and lasagna dinners, folding flood-gates around Manhattan and Norfolk, neighborhood Early-Reading Centers manned (and wommaned) with teachers trained and focused exclusively on teaching kids to read, renewable-energy electric grids that make fracking and transporting toxic waste-water completely unnecessary—but that would break the age-old rules of architectural diagramming: Keep it simple and symbolic. So I’ll do it like this:

What I’ve added is just a visual gesture indicating that the result of Sovereign Spending is the creation of something that “supports” the Private Sector pot itself—holds it together, keeps it from falling apart and rolling down the hill.

The important thing to understand about this “support” structure—whether it is services we provide ourselves (e.g. medical care), or structures and technology we build for our collective benefit (e.g. charging-station networks for electric vehicles)—is that what can be accomplished is not limited by the number of Dollars available for Sovereign Spending. The limitation, instead, is imposed by the real resources—labor, materials, energy, and technology—which are sustainably available to implement our collective goals.

8. The Right Words—a diagrammatic necessity

There’s only one thing left to make our new diagram useful for guiding the design of an informed and constructive National Budget. We need to decide on the proper terminology we’ll use to talk about—and measure—the flows that are occurring in the new diagrammatic plumbing. If we use the wrong words, or if someone uses one set of words and somebody else uses another, there could be a lot of confusion and misunderstandings. So a consistent and accurate “diagram terminology” is important.

For example, we might want to talk about (and measure) the number of Dollars that are proposed to flow, in a given budget year, from the FG spigot into the PS pot—and compare that to the number of Dollars that are drained out by taxes in that same year. In the old diagram (the one Congress is still struggling to use) the difference between what the FG spends and what it “collects” in taxes is called “The Deficit”. It would be called a surplus if the FG “collected” more in taxes than it spends, but since that rarely occurs, this measurement is almost always called “The Deficit”—and the FG spending that occurs beyond what is “collected” in taxes is called “Deficit Spending”.

“Deficit Spending” is a very powerful and frightening term. It conjures up the idea of digging a hole you can’t get out of. Indeed, that is precisely the dilemma the old diagram poses. It’s intuitively obvious to everyone in the PS pot—all the households, businesses, state and local governments—that if they spend more money than they take in, the hole that deficit spending creates has to be filled back in (or the households, businesses, state and local governments will be forced into bankruptcy.) In our new diagram, this reality remains unchanged—inside the PS pot.

But the new diagram also makes it clear that when the “Sovereign Currency Issuer” issues and spends more Dollars than are drained in Taxes, it is not digging a hole at all. There is no need—and, indeed, it is not even possible—to put replacement Dollars back into the “Sovereign Currency Issuer”! How can that be?

Again, it’s because of the underlying reality of what a Dollar actually is. Here it is, one more time: A U.S. Dollar is an I.O.U. issued by the sovereign U.S. government which says, “I owe you one Dollar’s worth of credit on the Federal Taxes you owe me.” Because the FG doesn’t have to “earn” Dollars (or anything else) in order to fulfill this promise as many times as necessary, by logic it can never have a “deficit” of its own I.O.U.s. In contrast, all of us who use those I.O.U.s for “money” (all U.S. citizens, businesses, state and local governments, for example) must earn them, or borrow them, before we can spend them. This is true for the simple reason that we are “users” of the money, rather than the “issuer” of it.

So the new diagram makes it clear that if the FG spends more Dollars than it drains in Taxes, it is inaccurate and misleading to call the difference a “deficit”. The FG is not deficient in anything at all! There is no hole that someday has to be filled back in. The calculation we are now trying to name is nothing more than the simple accounting of the number of Dollars, in a given budget-year, the FG issues and spends into the PS pot minus the number of Dollars the FG drains out of the PS pot when those Dollar “I.O.U.s” are presented (and cancelled) as tax payments.

Before trying to think of a more accurate and less confusing name for this calculation, however, we should consider an important question: What is the result if Congress actually succeeds in achieving its on-going aspiration to create a “balanced budget”—or even the holy grail of a “budget surplus”? The old diagram clearly begs for this goal—if the FG could just manage to create a budget that enabled it to collect more tax Dollars than it needs  to spend, then the Federal Government would, at last, be “fiscally responsible” and not have to “borrow” all those Dollars to make up its shortfall!

But our new diagram reveals the remarkable folly of this perspective when a sovereign government is its own “currency issuer”. Here are a series of simplified “plumbing flows” showing each of the conditions we’ve discussed:  A “budget deficit”, a “balanced budget”, and a “budget surplus”. In each case, the diagrams begin with the Private Sector pot containing the net Dollars (savings) left over from the previous budget-year cycle.

In the first diagrams (“budget deficit”) we can see that, in the given budget-year, the FG has drained out fewer tax Dollars than it has spent into the PS pot. The result is that the Private Sector retains an additional net savings of the Dollars the FG has spent. Those Dollars can be literally “saved” if they are put in Certificates of Deposit at a bank, or transferred into Treasury Bonds—or they can be invested in new business ventures. In either case, the net Dollars remaining in the PS pot are an expansion of the financial “wealth” of the Private Sector in general. Why would we want to call that a “Deficit”?

In the second series of diagrams, Congress has finally achieved its “balanced budget”. It has, for the given budget-year shown, drained out of the PS pot the same number of Dollars (in taxes) that it has spent into the PS pot. The result? The Private Sector, in that budget-year, has ended up with zero new net savings. In general, the financial “wealth” of the Private Sector is the same as it was at the beginning of the budget-year. The only logical reason the FG would want to constrain that wealth would be if price inflation had become a threatening condition in the PS pot. Otherwise, the “balanced budget” simply imposes an austerity on the Private Sector without rhyme or reason.

In the third diagram, our Congressional leaders have achieved what they believe to be their greatest goal: a “budget surplus”! They have actually managed to spend fewer Dollars into the PS pot than they have drained out in taxes. But what they view as a “surplus” is actually a net deficit for the Private Sector: at the end of the budget-year, the PS pot actually has fewer Dollars than it started out with. The result? In order for the Private Sector households and businesses to maintain what had been their current level of expenditures (their “lifestyle” so to speak) it becomes necessary for them to spend their savings from the previous budget-years–or to borrow bank Dollars to make up the difference. If Congress runs a “budget surplus” for long, the Private Sector will either have to diminish its economic activity in general (go into recession)—or plunge hopelessly into debt (borrowing bank money it can’t repay, possibly causing a banking crisis)—or both.

The idea, then, of looking at the difference between what the FG spends and what it drains in taxes in terms of “deficit”, or “balance”, or “surplus”—and using those terms to somehow guide our national budget-planning process—is clearly not a functional view of reality. Applied to a sovereign “money Issuing” government, which is creating and issuing its own tax I.O.U.s, the terms are completely meaningless. Worse than meaningless, these terms create an intuitive misunderstanding that can do (and has done) irreparable harm to both our collective good and the private well-being of tens of millions of real American citizens.

9. Let’s call it: “Net Spending Achievement”

My first attempt at a more useful term for describing the difference between what the FG plans to spend in a given budget-year, and what it plans to drain away in taxes, is “Net Spending Achievement”.  Economists may not like it much but, as an architect, I find this phrase appealing for the simple reason that it strongly suggests the purpose of Sovereign Spending, first and foremost, is to actually build something concrete and useful for our collective good. The emphasis of the phrase is not numerical but visionary. The actual “net number of Dollars” spent is unimportant (unless price inflation is a problem). What is important is what we actually decide and agree to achieve with that spending.

Please imagine, for a moment, how our political discourse might change if everyone understood the discussion was no longer about the size of our national “budget deficit” but, instead, was about the concrete goals of our annual “Net Spending Achievement”. This is what our new diagram is asking us to do.

10. Do we really  have a “National Debt”?

We won’t attempt to re-vocabularize all of conventional economics, but there is one term our new diagram clearly begs should be reconsidered: the “National Debt”. This term competes aggressively with “National Deficit” to sow confusion and chaos in our Congressional budgeting process.  Evidence of this confusion is a digital “clock” on Sixth Ave. in Manhattan (it used to be on Times Square) that tallies up, in real time, the U.S. Dollars which are transferred from Private Sector “Dollar” accounts into Treasury Bond “accounts” paying interest. The accumulating number is staggering (which is why, of course, the clock is such a novelty)—and terrifying, because it appears to measure (using the old diagram Congress seems hopelessly stuck with) the number of Dollars the Federal  Government has borrowed to make up its “shortfall” in tax collections. Here’s what the “clock” reads as of today:

Followers of this “clock” like to take this number and divide it by the U.S. population, generating the share  of the “National Debt” each private citizen will, some day, have to repay—currently:  $54,293.48. (And it keeps going up!)  How is each of us ever going to manage to pay that off? How could the U.S. Federal Government even think about borrowing that much money? Panic in the streets!

If we take this “clock”, however, and insert it in our new diagram, we can see it is actually measuring something quite different than what the “National Debt” perpetrators lead us to believe.

As we can see, there is no logical place to connect the “clock” other than at the flow between the PS pot and the “Treasury Bond Account Chamber”. The “clock”, then, is actually measuring the number of Dollars in the PS pot which have been transferred from a “Dollar” account (which pays no interest) to a Treasury Bond account which does pay interest—in exchange for the pledge that those Dollars will be kept tucked away in the Bond account for a specified period of time.

After the agreed upon time period, the Dollars are simply transferred back to the “Dollar” account in the PS pot from which they came. In most cases, what happens next is that the owners of those Dollars want to “roll” them back into the Treasury Bond account (as quickly as possible) so they can continue to draw their “free” interest payments from the FG spigot.

The “clock” then, is not measuring “borrowed” Dollars that have to be “repaid” or “replaced” in any logical sense of those terms. It is simply measuring the real financial wealth which U.S. citizens, businesses, state and local governments have moved into a savings account (Treasury Bonds) at the Sovereign Central Bank. Semantic logic, therefore, would have us give it a new name: It is, in fact, the “National Savings Clock”!

Now when New Yorkers walk down Sixth Ave., rather than panic at the financial hole they’re in, they can actually feel a sense of security at the enormous wealth they have collectively earned and saved.

If you’re concerned the FG still has to pay interest on all those saved Dollars (which it does) just remember that those interest payments are simply made with Sovereign Tax I.O.U.s which the Federal Government has an infinite supply of—and remember, too, that the net result of this savings and interest operation is to prevent trillions of U.S. Dollars from chasing goods and services in the PS pot (which helps control price inflation.)

11. Why we should LOVE our new diagram

So there it is: an architect’s attempt to draw a diagram that might be a more constructive guide for our National Budgeting process than the diagram Congress is currently struggling to make work. It may look like a Rube Goldberg machine (architectural diagrams—especially ones visualizing flows—tend to have that flavor) but the National Budget “edifice” it makes possible is quite remarkable. To summarize, what the diagram is showing us….

  1. We do NOT want a “balanced” budget—or, even worse, a budget “surplus”! What we want (as long as price inflation is under control) is the largest and most effective “National Spending Achievement” we can envision.
  2. The “achievements” we can realize are NOT limited by how many Dollars are in the U.S. Treasury, because the U.S. Treasury literally has an infinite number of Dollars to spend (as long as price inflation is under control).
  3. The “achievements” we can realize are limited ONLY by the real, sustainable resources (labor, materials, energy, technology) which are actually available in exchange for the Sovereign Spending.
  4. “Entitlement” and “Discretionary” budgets do NOT have to compete with each other for a fixed pot of Dollars. As long as price inflation is under control, whatever Dollars are necessary can be allocated to the “National Spending Achievement.”
  5. The U.S. Federal Government will never have to—or, indeed could it—“borrow” U.S. Dollars from China. Like anyone else who holds a zero-interest bearing Dollar, the Chinese can transfer their Dollars into Treasury Bond “accounts” that will pay them interest—but, as we now understand, the FG is not “borrowing” those Dollars from China or anybody else! 

Finally, in contemplating our new diagram, the most astounding and empowering thing to “see” is that while it remains emphatically true that we, as individuals, are financially constrained by the finite number of Dollars each of us can earn and save—as a collective society, working and cooperating together, we have all the financial resources necessary to pay ourselves to accomplish virtually anything we are capable of. This, in the end, is the astonishing “truth” that will solve the “unsolvable” dilemma of our National Budget.

56 Responses to DIAGRAMS & DOLLARS: modern money illustrated (Part 2)

  1. Dear All

    I suggest you replace “Federal Deficit” with a two word name, something like “Investment from Washington”.

    It is important that you all realize how hard a task you face. Very young children trade things. Not all children but very many behave this way ‘naturally’. Their trading is based on a fixed set of things to trade. Those who create new things are often thought to cheat.

    I suggest that the behavior of trading and the idea of a fixed pool of assets is ‘wired into’ most of us (i.e., present at a very early age, very hard to change, and likely to have been put there by the natural selection of
    human behavior, i.e., cultural evolution).

    We have many such evolutionary relics that we must deal with to make our modern society. The notion that
    heavy objects fall faster than light ones is a perfect example to those of us who know physics. If we do not
    replace ideas like that, we cannot build buildings or make machines!

    Indeed, a great deal of training (e.g., of airplane pilots) is to remove evolutionary relics that interfere with
    desired behaviors.

    Indeed, most of mathematical physics (e.g., the design of airplanes or integrated circuits or computers) is to replace the simple forms of cause and effect (one variable has an invariable effect on another) with the reality of field theory in which ‘everything’ interacts with everything else.

    The way for you all to proceed is to ignore the evolutionary relic of “budget deficit”.
    Every time you mention it TO THE PUBLIC AND TO THE POLITICANS you reinforce what you seek to
    replace.
    Rather present the alternative again and again until your correct metaphor is finally accepted.
    Present your SINGLE correct graph and metaphor again and again until they are accepted.

    A great deal of teaching is repetition of key ideas.
    A great deal of leaning is remembering those key ideas
    and THEN (only then) using them in new contexts.

    Repetition and learning precedes using.

    Good luck!
    Thanks VERY much for all you all are doing for all of us.

    Ever yours
    Bob Eisenberg
    Bard Endowed Professor and Chairman
    Dept of Molecular Biophysics and Physiology
    Rush University Medical Center
    Chicago IL

    CV: https://ftp.rush.edu/users/molebio/Bob_Eisenberg/Reprints/Webpages/Full.CV.pdf
    Webpage: http://www.phys.rush.edu/RSEisenberg/physioeis.html

    • Bob: I am very appreciative of this commentary–and the one earlier as well. The parallels you describe with your own efforts and realms are, for me, very provocative. I understand full well the dilemma you lay out regarding the debunking of a false argument by stating the false argument itself–the danger in doing that. But my instinct is you cannot ignore the status-quo–you have to call it out and challenge it. My intention is to turn this essay into a small Ebook on Amazon–and in doing that I’ll try to temper the frame, based on your admonitions…. Thanks again for your suggestions.

  2. That is a great and useful gedanken experiment to read. Taxes as you note are a powerful tool for controlling inflation however there is another factor. Taxes and the system structure should also provide an environment of equality in the PS. And we do not now have that equality. While the notions about budget, deficits, debt are all ways of thinking that establish their own reality, our inequality is a reality, not just a way of thinking. For example, that T-Bond savings account is primarily held by a very select few; it is not held equally by the entire PS as shown in your diagram. I would challenge you, with your obvious gifts for teaching, to include the issue of fairness and equality in your diagrams and words.

  3. Part TWO is fantastic, FANTASTIC, “””FANTASTIC””” Thanks very much.xxx

  4. I LOVE hydraulic diagrams! This should be animated, given catchy tunes, and played between all the cartoons ala School House Rock. Nicely done!

  5. Jon Harrison

    I’ve seen this type of analysis a number of times, although this is by far the simplest explanation. Whilst I agree with the view that this is how things “really” are I disagree that it would help to change the way in which governments approach budgetary spending. The reason is simple: credibility. In the days of the gold standard the credibility of the government and the financial system depended on not creating any more money than there was gold to back the money. In the fiat financial system credibility depends on governments respecting the accounting identity that spending equals taxes plus borrowing. Any government that either says it will issue money to “pay back” all the borrowing or that it will allow the borrowing to run up indefinitely will lose credibility and will find that markets will devalue their currency with real economic consequences. This is, of course, implicit in the statement that currency issuance, taxes, borrowing and spending are managed in a way so as to control inflation, however, it is the very framing of the system in terms of spending equals taxes plus borrowing that ensures that inflation will be controlled.

  6. Someone wheeled one of those “National Debt Clocks” on to the University campus in my home town last fall. The local news spent an inordinate amount of time covering the story being told by it’s misinformed owner. I’m thinking of building a similar one with “Savings” placed where they use “Debt”.
    I have heard from a recent MBA graduate that the models presented in part 1 define quite closely the understanding most of her classmates had taken away from their university education so it’s little wonder that kind of thinking is so deeply entrenched. “That’s what you learn in business school” were the words. I recalled the expression from a character in the film “The Matrix” who exclaimed ” what a mind job!”. Most of us believe the opposite of reality regarding national debts, and we didn’t get that because of poor intuition, it’s what we hear all around us drowning out our own rational thoughts.

  7. Great presentation of the fundamental relationship between the government and domestic sector and I particularly like the transition from ‘how we think it works’ to ‘how it actually works’. I know that a perennial difficulty faced by those who get MMT is persuading others that MMT is indeed a description of what exists not some kind of economic mumbo-jumbo. Hopefully this approach will do the trick, or advance people’s understanding.

  8. Thanks Mr. J.D.Alt!

    My post of this morning, “Positive Taxation as a Method of Measuring Monetary Stimulus” ( found at http://mechanicalmoney.blogspot.com/2014/01/positive-taxation-as-method-of.html) supports Mr. Alt.

    My term for “Net Spending Achievement” is “Positive Tax”. It can be measured easily. The effect of bank lending can also be easily represented as a “Positive Tax” and is shown using Federal Reserve data for the last 40 years.

    A chart from the post showing “Net Spending Achievement” (or my term “Positive Tax”) can be accessed directly from the Federal Reserve at http://research.stlouisfed.org/fredgraph.png?g=qIf.

    My only difference with this Alt post goes to the need and emphasis on taxation as support for a fiat currency. Yes, the currency issuing agency MUST accept the currency for payment of taxes or currency failure is to be expected. However, currency acceptance can occur without a taxation element as has been demonstrated by numerous past examples. Taxation is a very useful tool for economic direction.

  9. This is great!
    A Youtube animation has to be in the works.

  10. “If Congress runs a “budget surplus” for long, the Private Sector will either have to diminish its economic activity in general (go into recession)—or plunge hopelessly into debt (borrowing bank money it can’t repay, possibly causing a banking crisis)—or both.”

    This sentence could be enhanced by admitting to the possibility of deflation as another alternative. In fact, the problem is that deflation alone won’t for reasons that can be discussed. Deflation will happen in concert with recession and borrowing. If we could create deflation without the other two, then maybe it wouldn’t be so bad. We might have to talk about the PS pot in terms of the sectors within the PS pot and the transfers among them that is implied by any particular set of government policies. Deflation transfers wealth from borrowers to savers. Inflation transfers wealth from savers to borrowers.

  11. Excellent post JD and very useful diagrams. It’s even accessible to our economically challenged Congress critters if they were willing to take a look at it. I still like the term “National Investment” rather than “National Spending Achievement” because I think it conveys a more positive image (after all, spending is not much of an achievement, what is created with the spending is the achievement), but that’s just my preference. I plan to cite this post to anyone who asks for or is open to clarification of MMT positions.

  12. I really enjoyed these two posts and appreciated the clarity. One of the things that is confusing for me (and perhaps only because of the language used by government and media) is the relationship between the treasury and the federal reserve bank.
    I kind of think of “The Treasury” as the arm of the federal government that cuts checks to people and organizations for the goods, services, and labor they supply. So it is tempting to think of them as the money creation engine.
    But from my reading of economics textbooks, they always talk about the FOMC as having the control over the money supply through its purchases and sales of US Bonds (and more recently, MBS).
    So does the treasury go to the federal reserve bank and say “hey we need some more money.” And then the FOMC says “OK we’ll auction off some treasury bonds and deposit the proceeds into your account.” Is that how it works? So the thing of value being created out of thin air is the debt of the treasury with a promise of repayment with interest. Am I getting this right? What’s to stop the federal reserve from auctioning off treasuries and placing the proceeds in, say, Bank of America’s account? Are there laws against that? Is there transparency to that?

    Also, when you say the “public” holds the treasury debt…what does that really mean? I don’t have a pile of Treasury bills laying around my house. I suppose people can invest in ETF or Mutual funds that hold these instruments. Banks can hold these instruments as assets, and so can foreign sovereign funds or central banks. But does it matter at all WHO is holding them? Is one sort of investor holding these better or worse than another?
    Who decides on the mix of maturity of the outstanding debt? Short term, long term, etc. If congress is so concerned about future inflation and/or future repayments, can they make the chairman of the federal reserve only sell securities with a long time to maturity, like 20 or 30 year notes? Then we could retire all our short term obligations and have rates locked in for a relatively long time.
    As far as I can tell, the secretary of the treasury saying things like “we will run out of money by XYZ date…” really has more to do with idiotic congressional debt limit legislation than any true supply of money issue.
    Also what gets me confused is what exactly IS the federal reserve bank. From what I understand it is a bank that commercial banks pay a membership fee to, and these commercial banks have accounts there, and can go to the federal reserve as a lender of last resort. But does the federal reserve bank make profits, and where do the profits of the federal reserve bank go? In a normal commercial bank, the profits would go to the owners. Who “owns” the federal reserve bank? Are the profits returned to the “member banks?” That wouldn’t seem right, particularly since the federal reserve also has a regulation component. It seems really weird to me that a bank like JP Morgan is a member bank of the Federal Reserve, has an account with them, and is also regulated by them. My bank doesn’t portend to regulate me!

    Sorry for the barrage of questions, but when I see someone who can explains something with any sort of clarity, I always want to see what I can learn. I have always been confused by this, despite (because of?) my BA in economics. I also never like to pretend I know something unless I can explain it myself to someone else in minute detail.

    • Well, I just happened to buy my first Treasury bill the other day. You can buy them directly from the Treasury at TreasuryDirect. In my case, since I wanted to buy the bills in my tax deferred accounts, I had Fidelity buy them for me. Fidelity charges no fee for this service.

      The Fed has nothing to do with issuing Treasury securities (a far as I know).

      And I fully agree that this two part series was excellent. I am featuring it on my blog, and my reflectors at Facebook, Google+, and Twitter.

    • Dan,

      There’s lots to read on all those subjects. Try the links on the right side of this page. The MMT Primer covers most, if not all, your questions. Briefly, though,

      “I kind of think of “The Treasury” as the arm of the federal government that cuts checks to people and organizations for the goods, services, and labor they supply. So it is tempting to think of them as the money creation engine.”

      That is correct, according to MMT. Money is created when it is spent by the government (Treasury).

      “FOMC as having the control over the money supply through its purchases and sales of US Bonds”

      This is for the M’s as measures of the money supply. Different paradigm. Treasuries are near-perfect substitutes for deposit balances, so it makes little sense to differentiate. The M’s are not having much effect these days, and probably never did, as such.

      “So does the treasury go to the federal reserve bank and say “hey we need some more money.” And then the FOMC says “OK we’ll auction off some treasury bonds and deposit the proceeds into your account.” ”

      No. Treasury sells (auctions) new issues of bonds on a regular basis. They sell a variety of maturities. Short-term debt is called Notes, then there are Bills, and the longest are Bonds. It’s all described on the Treasury web site. They time the sales and volume to periodically fill up their “checking account” at the Fed (called TGA), from which they spend. Like us, they always try to keep a positive balance in their account. Tax receipts go into TT&L accounts, and they transfer money from there to the TGA as needed, also. The manipulations are done in coordination with the Fed to ensure that there are always enough reserves in the system (less important now that there are massive excess reserves, added by QE).

      The Fed’s OMO mostly consists of buying Treasuries in order to add reserves to the banking system, so as to hit their overnight Fed Funds target. Actually, the majority of the transactions are repurchase agreements to manage daily fluctuations in reserves. Permanent additions through outright purchases and sales are done only to manage longer-term trends. And all that is out the window with QE and interest on reserves. The IOR rate now is what keeps the Fed Funds rate positive. If they are still doing repos, I can’t imagine why.

      When Treasury sells a new bond, it does create that bond out of thin air, but it simultaneously drains an equal amount of money from the economy, from the buyer of the bond. It’s a wash, an asset swap. When it spends money, nothing is subtracted from the economy. Spending is a net add. Likewise when the Fed buys or sells bonds, it is a wash. Makes no difference, except to the interest rate.

      “Also, when you say the “public” holds the treasury debt…what does that really mean?”

      Mostly it is Pension funds, the Fed, foreign central banks, and other agencies (like Social Security) that hold the bonds. Bond traders trade them. The Fed returns the interest it earns on them (in excess of its operating costs) to Treasury, about $90B last year. Other than that, it makes little difference who holds them. Individuals can buy them at the Treasury auctions, or through their stock brokers, but only a small percentage are held that way.

      “Who decides on the mix of maturity of the outstanding debt?”

      Probably the Treasury. It would have to be, I think. I recall only once any mention of it, that during the late 1990’s when interest rates were coming down, they deliberately shifted new debt to the short end, to minimize interest costs and thereby cut the deficit. For a while they didn’t sell new 30-year bonds at all. In MMT, there is no real reason for anything but short-term bonds, and a zero overnight risk-free rate.

      “we will run out of money…”

      Yes, that’s just the debt limit.

      “Also what gets me confused is what exactly IS the federal reserve bank”

      They have a web site, and a document there that explains everything. It’s not one bank, there are 12 regional banks that carry out the operations, and a committee and Board of Governors that directs them. It’s the Federal Reserve “System”. Commercial banks have accounts at the Fed, which are used for clearing drafts written on one bank and deposited to another. The Fed is also a regulator of banks. And non-banks. The 12 regional banks are corporations with shareholders, but have functions in the system that regular banks do not have. They receive coins from Treasury and supply them to commercial banks. They receive new FR Notes and distribute them to commercial banks, and receive old, worn notes from banks, to be destroyed. They regulate the banks in their region.

    • Dan, I feel your pain as I’ve been working through some of these questions over the last few months. The diagrams present a somewhat idealized view of the workings of a monetary system that is partially a legacy from the gold standard days and partially an artifact of legislation by people with a pretty hazy notion of what money really is and how it functions. As a result, we have things like the debt ceiling, and laws prohibiting the Treasury from writing checks unless it has funds in its accounts at the Fed, and laws prohibiting the Fed from extending credit (ie giving money) directly to the Treasury. So we have back door methods whereby the Treasury issues securities and the Fed buys them (in the open market), essentially permanently. What I would suggest is that you read more, like Mosler’s Soft Money Economics or Prof. Wray’s books. There’s also a lot of stuff you can find in the links of this website. You’re asking the right questions.

  13. JD, doesn’t the $17 +t figure include up to about 40% inter-government debt, for example the $2+trillion dollars in the Social Security Trust fund? Perhaps there should be a pipe from the FG to the Treasury Bond Saving Fund tank as well.

    • James Cooley

      Oops, should have written intra-government or inter-agency debt. Also Saving Accounts tank.

  14. Pingback: DIAGRAMS & DOLLARS: modern money illustrate...

  15. Joe Firestone

    This post was a home run J.D. The first post hit me as going over old ground in an obvious way. But this one went over the old ground in a way that I really thought would deliver the goods to people who need a gut understanding.

    I spent some time in a post at NEP some time ago trying to relabel terms like “deficit” and “debt.” My proposal was:

    So, here’s another proposal for renaming/re-framing key terms in monetarily sovereign government accounting.

    — When a monetarily sovereign government spends more than it taxes during a specific time period that is Government creation of Net Financial Assets (NFA) in the non-government sector. Let’s call it “the addition.”

    — The accumulation of net financial assets created over time is national net financial savings. Let’s call it “the National Credit.” The current total of debt instruments subject to the limit is equal to “the National Credit.”

    — When a monetarily sovereign government taxes more than it spends during a specific time period, then that is Government destruction of NFAs in the non-government sector. Let’s call it “the government destruction.”

    Accumulated NFAs destroyed by Government taxing more than spending is national net financial “depletion,” not “national savings.”

    Don’t know if these terms are any better than what you offered. Either way, however, I think we still haven’t found the right labels.

    • I suggested “net government demand” to replace “deficit”, but that only works for economists.

      Maybe we just need to ignore the deficit, and have a new term for taxes, like “private sector income destruction” or something similarly bad-sounding. The idea is that taxes should be used only to prevent inflation. Then government can spend what it needs to spend, and not worry about whether the necessary taxation is higher or lower than spending. They need to be thought of as unrelated entities.

      And a suggestion: when you pitch this to a general audience, as opposed to a homogeneous group of Progressives, I would downplay the idea that it is government’s job “to build and create goods and services that make us collectively healthy and prosperous.” Many Americans think that is the purpose of the PS. It’s why we all work our butts off most of our lives. The alternative story is that government needs to get out of the way: stop the taxing that is preventing us from working to make ourselves healthy and prosperous, and just tax enough to prevent inflation.

      • Miguel E Jimenez

        The FG spends money to build and maintain the infrastructure (composed of both goods like roads and services like education) used by the PS to provide other goods and services (mostly non-infrastructure; i.e., consumer goods and services).

  16. I think all members of congress should be required to view the forthcoming, hopefully, youtube video and take a multiple choice test at the end of the video. If they do not pass with score of 70% then, they are required to view the video again and retake the test. If they still don’t pass after 4 attempts then, they are barred from serving on any committee dealing with federal budgetary issues because they have not demonstrated competence in the elementary fundamentals of macro economics.

  17. I doubt any sane person, who has any respect for individual freedom and independence, would willingly agree to the self enslavement and control through a Government imposed tax system. Your statement, ” because we, the citizens, have agreed to the proposition that if we don’t pay our taxes with the Dollars the SCI produces, the FG then has the proper authority to put us in jail” is completely unfounded.
    While it is true we have to pay taxes in the government created currency, that is not the reason for creating the currency in the first place. The reason a currency is created is precisely why Lincoln created the “greenback”, “The government should create, issue and circulate all the currency and credit needed to satisfy the spending power of the government and the buying power of consumers….. The privilege of creating and issuing money is not only the supreme prerogative of Government, but it is the Government’s greatest creative opportunity. By the adoption of these principles, the long-felt want for a uniform medium will be satisfied. The taxpayers will be saved immense sums of interest, discounts and exchanges. The financing of all public enterprises, the maintenance of stable government and ordered progress, and the conduct of the Treasury will become matters of practical administration. The people can and will be furnished with a currency as safe as their own government. Money will cease to be the master and become the servant of humanity. Democracy will rise superior to the money power.”
    You may notice that Lincoln included the creation of “credit” in his summation of why a Government should issue its own currency.
    I cannot understand how the current monetary system can be discussed without including the huge amount of “credit” created by the private banking sector. You allude to this in your remark, ” then leverage them with bank loans” but ignore the fact that these “bank loans”, collectively, far exceed the amount of sovereign money created by the Government. How can you ignore this?

    • Guggzie, this quote from Lincoln is remarkable I think. Thanks for it. Where/when did he say this?

      • Although there is no specific date for the quote, which I picked up from googling “greenbacks”, it is related to 1863 when Lincoln had to ask Congress to supply additional “greenbacks”, That was when the bankers coerced Congress into passing the National Bank Act. From this point on, the entire US money supply has been be created out of debt by bankers buying US government bonds and issuing them from reserves for bank notes.
        The bankers quickly realised how dangerous Lincoln’s policy would be for them, and they had the London Times (Hazard Circular – London Times 1865) publish this article. While designed to discourage Lincoln’s creative financial policy, it actually does the opposite. “If this mischievous financial policy, which has its origin in North America, shall become endurated down to a fixture, then that Government will furnish its own money without cost. It will pay off debts and be without debt. It will have all the money necessary to carry on its commerce. It will become prosperous without precedent in the history of the world. The brains, and wealth of all countries will go to North America. That country must be destroyed or it will destroy every monarchy on the globe.”

      • I got a source for the Lincoln quote as follows:
        Abraham Lincoln, Senate document 23, page 91, 1865; Quoted by Rowbotham [Rowbotham, 1998] 220-1.
        The Rowbotham reference is Rowbotham, M., The Grip of Death, Jon Carpenter Publishing, Charlbury, Oxfordshire, 1998.

        I used it in my book Economia, http://betternature.wordpress.com/my-books/otherbooks/economia/ (p. 291)

  18. This is truly powerful piece that should properly and radically change the landscape of political debate on all deficit spending issues. Is there a way to make this mandatory reading for everyone in government and the political media?

    Shame, shame at the fog created over ‘deficit spending’ and ‘national debt’ by both political parties! A monstrous rhetorical deception of the American people! At best based on ignorance, more likely cynical & knowing manipulation of popular misconceptions!

    Bravo and kudos for this writing!

    NineInchBride.com

  19. reserveporto

    There needs to be more discussion of private banking and private money creation. The public dollars flowing from FG trigger the creation of private dollars. Those private dollars exist in the system until the bank that issued them goes bust. Even when it goes bust, the FDIC/Fed steps in and keeps many of the dollars created by that bank, which are indistinguishable to the user, from being destroyed. That private money flows to the savings bin and also out the tax spigot. The rate of private money creation is somewhat controlled by the Fed’s interest rates and by financial regulation. Private money doesn’t necessarily exist for very long, such as a credit card bill paid the same month, or sometimes much longer, like a mortgage, but there is always some amount outstanding and it is used in the same way as FG money.

    What if changes in financial regulation cause the flow of private money creation to increase? Such as lowering interest rates or legalizing liar’s loans. That also causes inflation.

  20. Nice diagram.
    The current diagram suggests that the size of the PS pot is of a fixed capacity. Pore too much in from FG to PS, where does it go? Over the sides? Would that represent inflation? That is, the whole dynamic of inflation as the limit to FG spending is not built into the diagram.

  21. I’ll tell you one thing, J.D., the next time I have a plumbing problem, I’m calling an architect.

  22. Just wanted to say thank you for posting these! I find them great at clarifying some of the MMT fundamentals, and am going to forward them to others when I want to explain the ideas.

  23. The model presented ignores exogenous influences, including the balance of payments deficits. Since a payments deficit is another “drain” on the system, a budget deficit is always necessary just to replace this drain of money.

    • Sunflowerbio

      Unless there is a trade surplus, in which case the government sector COULD even run a surplus, IE, drain more in taxes than it issues.

    • From what I have read, I think on this web site, the “foreign” payments don’t go anywhere out of the country. Since most significant payments are electronic, the money sits in an account at the FED ultimately. The account is most likely owned by a foreign government, say China, but the money is still here. Moreover, what is that foreign company going to do with that money? If it wants the money to be productive at all, it either buys U.S. goods with that money, buys US treasury bonds with that money, or buys something from another country that faces the same problem of what to do with the money.

      • If the money is an arrangement of bits on a computer disk, does the location of the money depend on the location of the disk? If the Fed outsources that computing task from their Washington data center to an IBM data center in Colorado, does the money then move to Colorado? If they outsource it to a provider in Canada, would it then move out of the country? If not, then where does the money reside?

        • golfer1john,

          You are the paranoid type. 🙂

          I, for one, have faith in the security precautions that the Fed takes to guard the trillions of dollars in electronic money. I have no idea of the answers to your questions, and I hope that few people outside the FED do either.

          If you can’t trust the FED to guard the money supply, who are you going to trust, Ron Paul and Rand Paul not withstanding? I bet they haven’t even thought to raise doubts about this aspect of the FED.

        • golfer1john – money are essentially a contract, so the location of the contract is less important than the location of the two parties to the contract – one is the beneficiary of the contract (me with money in my pocket) and the other is the supplier to the contract (the pool of labour of a nation that supplies a slice of labour against my dollar in my pocket)

        • The short answer is that the money resides with the Fed, since it controls which computer has the bits, whether the computer is located in DC, Canada, India, China, or on the moon.

        • Electronic money has no physical existence, therefore it cannot have a location. Money-things like dollar bills have a physical location, but even then the money they represent – the obligation of the issuer – is not a physical thing and has no location. I can take a dollar bill to China, but the money is not in China, or in Washington, or in Colorado.

          My point is that it makes no sense to say the money moves, or that it doesn’t move. It is owned by someone, but it is not located anywhere.

          As for security, I’m hoping the Fed still uses IBM mainframes to keep track of this, and not Windows servers, or else we are all Target shoppers. And yes, I am appropriately paranoid about any information made available on the Internet.

  24. I suppose the view expressed in the first section is so prevalent is due to two reasons:

    1. Gold standard leftover thinking
    2. This is the way resources circulate. You are right inasmuch as the dollar bills circulate from the FG/government to the PS/Private Sector, and they have to be injected in the system before they can be taxed, and they are destroyed on collection. However, real resources circulate as per the initial diagram, i.e. the PS/private sector creates resources, and the FG/government taxes them. Yes, the taxes are expressed in dollars, but let us not forget that in effect the government does not tax dollars, they take a slice of the resources of the PS in order to run. Dollars are just the visible/accounting expression of this, and they circulate the other way. Anyway, most people will have a feel for the fact that resources circulate as per first diagram, and this is why this diagram is so ingrained in everyone’s perception. As I said elsewhere, we are talking about two different levels/embodiments of the same phenomenon – circulation of resources – expressed in different ways, and the money are just one layer of the three or four layers that exist.

    I think we are mixing layers too much, without being aware that these layers exist, and if we mix them, then we create a lot of the logical mismatches/questions/problems that pop up again and again in this and other blogs.

    Let us think more in layers and a lot of the fog will clear

    • Good insight about the circulation of resources.

      Government taxes because it needs real resources, and cannot create them itself.

      Private people and businesses give real resources to government because they are forced, at first, and now because they want money and cannot create money themselves.

      Reinforcing the point that net financial assets come from government, not from the private sector. (Even though banks create money, because bank money is offset by debt and no net financial assets are created.)

  25. Thanks JD. Clarity at last. No jargon, no references to obscure, unexplained processes, no thickets of defensive asides, just the essence. MMT now seems to make sense, and to fit with my notions of what money is (IOUs basically).

  26. What’s sad is that even given this amazingly simple demonstration and explanation of the reality of our economy, people refuse to listen.

    You can lead a republican to facts, but you can’t make them listen or retain information.

  27. For clarification purposes, is this model suggesting taxes are not necessarily used to pay for public services, but are a method for controlling inflation because of the new money injected by the FG?

    And if this is true, how does a budget deficit add to the national debt — as is taught in ECON 101 — if the money injected by the FG is simply created, not borrowed?

    I hope my questions are clear enough. This is a very useful model, I am just trying to straighten a couple of things out in my head logically.

    • 1. Yes.
      2. It wouldn’t. The “national debt” is the outstanding volume of Treasury securities. It is very very close to the sum of the annual deficits, but not exactly, because sometimes the government does actually spend without taxing or borrowing. Coinage is the most fundamental example, but during the Civil War the Treasury deficit spent by issuing “greenbacks”, paper money that was not funded by borrowing. There may be other, more obscure instances as well. It was hinted at during the last debt ceiling approach that some accounting tricks were done to allow deficit spending without borrowing.

      • US Notes were printed and spent without borrowing until the 1970s. There were also Kennedy’s silver certificates. You will remember the US Notes. They had the red serial numbers. There was little discussion of this printing and spending which was all done, as I understand it, under the legal tender act passed for Lincoln to print the famous “Greenbacks”. The demise of this process was very quite, done with little fanfare and, I am sure, was performed by a very deliberate “lobbying” action by banks.

  28. Thanks for this informative article. Just one point – since many bonds are purchased by financial institutions and involves an exchange of bank reserves for a bond account at the Central Bank, there may actually be no change in the money supply. So I believe some MMT proponents would argue that bond purchases are irrelevant as to whether inflation occurs.

  29. Alex Seferian

    I very much enjoyed these posts and they made me come to an interesting realization that I wanted to run by everybody. See if I am correct.

    This realization is that both sets of diagrams (Part I and II) are accurate. It all depends on one’s views concerning what flows through the pipes?

    The Orthodox View:

    If money is “neutral”, only serving as a lubricant between the exchanges of different commodities, then this camp considers that what actually flows through the pipes are real resources.

    It is interesting to take the Part I diagrams and replace money with real resources. Human resources sit in a top (Private Sector) pot. The “Government Spending” and “Taxes” pipes have essentially to do with controlling part of those resources: a) Taxes serve to de facto appropriate the labor, moving people from the private to the public pots, and b) Government Spending serves to recycle back to the citizens the resulting real goods and services.

    If one looks at things through this lens, there should actually be no “deficits”. Congress establishes “public purpose” goals (e.g., maintain a military force, provide medical service, etc.), and then goes into the Private Sector and grabs exactly what it needs to get the jobs done (9 millimeter in hand thanks to the taxman).

    Conclusion: The Part I diagrams are accurate if what flows through the pipes are real resources.

    MMT’s View:

    MMT explains what actually happens in a modern (fiat) monetary system.

    What flows is something originally produced by the government and virtual… akin to scorekeeping points as Warren Mosler often remarks.

    Conclusion: The Part II diagrams are accurate if what flows through the pipes is money.

    So what really flows through the pipes?

    This series has helped confirm that the debate surrounding “budget deficits” has a lot to do with one’s beliefs regarding the nature of money; a subject matter covered in recent NEP posts (Wray)… so all this ties in very nicely.

    Clearly, money is what flows through the pipes. However, my sense is that one still has to give the orthodox theorists some credit, as money is in reality a “means to an end”.

    Yes, money is a key driver in a capitalist economy, and it is not “neutral”, but at the end of the day, most rationale people earn and save to ultimately spend, or to grant more spending power to their children and/or heirs, or to endow their favorite charities.

    Conclusion: what flows in the diagrams’ pipes is as much money (the “means”), as it is real resources (the “end”).

    What about the debate on deficits?

    Taking the above into consideration, it is not that misleading when some politicians intuitively focus on the real flows in an economy, which is what I argue they are doing when they try to implement policies to achieve more balanced budgets or trade accounts.

    Take as an example the concern expressed over China. Of course, technically it is incorrect to argue that the US is borrowing too much from that country; those who say so clearly don’t understand the way the international payments system works.

    However, it is technically as incorrect to say that exports are a real cost, and imports are a real gain. International trade is a two-way street involving parties voluntarily agreeing to a deal. Exports are a real cost only considering the 1st half of the transaction, when the exporter exchanges a “real” good or a service for “paper”/currency. However, the expectation is that the importing country will eventually (in years or decades) sell a real good or service back (to the same country or another… it makes no difference). The point being that if the 1st trade is never reversed, then the importer will have received something for nothing… an outcome that as a point of logic cannot exist forever.

    Therefore, all other things equal, eventually when China starts consuming more, then the US will have to consume less to avoid inflation; i.e., increased taxes will be needed. This is not a question of “if” it will happen, but “when”, again “all other things equal” (a helpful premise to isolate variables in an analysis).

    The conclusion is that a budget deficit that for example helps fuel a trade deficit, may or may not be appropriate. It depends on a myriad of factors, including how consumption has compared to investment. Importantly, short-term inflation cannot be singled out as the sole metric to gauge, as I understand MMT suggests, when determining the adequacy of a policy. The Chinese could be net exporting for decades, with no consequences during the period in terms of US inflation. However, the often-referenced “future generations” may be indeed the ones bearing the brunt when the Chinese change their savings desires. In a sense, the orthodox discourse is not totally irrational, even though technically it messes up things when it talks about borrowing money from China.

    Coming back to the deficit debate, I believe that it is a political matter, mostly about who gets what and when. Most government initiatives have to do with the size of the pie and how to cut it up. Some government initiatives can make the pie bigger for the benefit of all, and some can actually reduce it.

    The greater the budget deficit, the greater the inflation build up, and also the greater the potential to affect the pie and slice it up… for better or for worse (depending on where one is seated at the table). So… to the extent campaign financing continues to play such a major role in US politics, then Congress will continue to define public purpose in relatively narrow terms, and adapt diagrams and theories such that the risks associated with distributing real wealth to the “other” segments of society are kept to a minimum. In a nutshell, members of Congress will lean towards keeping the government relatively small, and benefiting those that helped them get elected. Referencing if I recall correctly one of your other excellent posts, the system needs to foster the “cooperative gene”.

    • I would be very cautious of trying to just use the same diagrams and replace the flows of money with flows of real assets. It is just not as simple as that.

      I don’t know how many of you are into physics, but there is a similarity here between the duality of light discussion (or matter for that matter). Is light a particle or a wave (actually the same issue for electrons and other sub-atomic “particles”)? Well, in fact light and these sub-atomic things exhibit wave like properties under some circumstances and particle like properties in others. The similarity with money is that money has some purely made up or fiat properties under the right circumstances but it also shows some real asset properties in other circumstances.

      So in physics, what light and sub-atomic particles really are is not either matter or waves. The concepts of matter and waves (money or real assets) are just models (simplifications) of reality. They may be the best we can do to put it into words, but there is something more to reality than we have been able to put into words so far. we may never actually be able to describe reality completely in words.

      So we need to try our best to get our minds around these complexities, but we need to stay humble about how difficult it is. The diagrams of these article are very enlightening and are a major breakthrough in my opinion. A similar amount of effort and the genius that went into these diagrams will have to be put into coming up with a description of “real” assets to match this description of money.

      I encourage everybody to work on it. I just caution people against thinking that it will be easy to jump from one interpretation of these diagrams to the other interpretation. This is also not meant to minimize the ideas put forward by Alex Seferian.

  30. Question on the diagram:

    Fist let me say that I really like the model and it’s explaination, but wouldn’t it be more apt to place the spigots for the interest and principle from FG into the treasury bond chamber? Isn’t this more true to how money enters the economy, IE via the banking system? Yes some funds are pumped directly into the PS, but a majority of it is pumped straight into the banks that then use fractional accounting to create larger loans.

    Also, would it not be useful to show how the funds that are pumped directly into the PS are divided up between the class and/or corporations. In addition to this, one could also so a relation to how the poor, the middle class, rich, and business then operate between each other.

    In a very real way the poor operate in a kind of “surplus” spending mindset as laid out by this model. That is to say, their outflows are often greater than their inflows. The middle class can be seen as operating in a kind of “balanced budget” mindframe where they don’t really get to grow, and honestly teeter on exceeding their inflows and becoming a “surplus.” Likewise, the business and rich tend to operate more in a “deficit spending ,” where they are capable of saving vastly more than other parts of the economy.

    This could also be used to relate how and why taxing both business and the rich at higher rates is inducive to a healthy economy. As they retain the most capital year to year and are in a sense responsible for any inflation we really see.

    A further addition I’d make is to add a “profits” outflow from business that shows how money leaves the private sector and enters a holding tank where it is no longer participating in the economy as a whole.

    Just a few thoughts, I’d love to hear back on them if you have time.

    To author: I have even considered doing up a diagram to reflect these if you wanted to see them.

  31. Louis Paul Hebert

    Instead of “Net Spending Achievement”, how about “Payments to the Private Sector”. Because that is the purpose of the spending.

  32. I enjoyed the parts of this pair of articles that I read. (I already know a lot about MMT, so I did not read everything.) I have only one quibble, and that is with the notion that FG spending is necessary to the creation of private money. IF the FG spends, then it will want to create its own money, and its own money will become the money everyone uses. Banks will borrow FG money from the public and lend FG money to customers. But that choice will be a competitive one, i.e., the FG money will simply be better than any other money. But in the absence of FG spending, there would still be bank notes, just as there were once goldsmith’s certificates and other instruments of credit. In other words, these articles are not about how “money” works but about how FG money works once it has been established as the money that everyone uses.”

    I also believe some point should be made of the distinction between the Treasury and the Sovereign. Most of the people who resist MMT think that the Treasury is the Sovereign. So, if you tell them that the Sovereign spends money into existence, they respond that, legally, the Treasury cannot spend money that it does not have. And they are right. The Treasury under our system of governance cannot spend money it does not have. The Treasury must receive taxes or borrow in order to spend. Thus, the saving account box only makes sense when the central bank is introduced and it is understood that the decision by the central bank to buy the Treasury securities is what determines the extent to which the Sovereign is spending money into existence. Only the money that is lent to the Treasury and not replaced by Fed purchases is put in the box. To the extent that the Fed buys Treasuries, the money leaves the box and goes back to the PS.

    As regards the $17T debt clock, it’s useful to point out how much of that “debt” is held by the Fed. That money is not in the saving account box; the paper is held by the Fed, and the money is back in the PS. Then there are the entitlement trust funds, and the entitlement promises. It gets complicateder and complicateder. But the fundamental demonstration that taxes and Treasury borrowings do not fund the government is very valuable, and I couldn’t agree more that the term “deficit” is powerfully harmful. But I don’t believe there is any way to replace it. Rather, we need to recalculate it in a way that ignores as expenditures money for capital assets, with perhaps some creative definition of “asset.” The purpose of the US government is to secure the blessings of liberty for us and our posterity. That it gets no credit on its balance sheet for having done so is nuts. In other words, we cannot get rid of the notion of a deficit, but maybe we can find a way to calculate it in a way that makes it disappear.