To Consolidate or Not To Consolidate, that is the Question (or maybe it isn’t)

By L. Randall Wray

This is another short post on MMT, a sort of follow-up to my post from a couple of days ago. There was an interesting response to various comments on my piece, which was posted up on Mike Norman’s website.

We got the typical: “oh you MMTers always want to consolidate the Fed and Treasury, but really the Fed is a private institution that is not a part of government”, and “in reality the Treasury cannot spend unless the Fed will allow it to spend, otherwise it must get tax revenue before it can spend”, and hence “really government spending is constrained by its revenue, just like a household or firm”.

In reality, what MMT has shown—from the very beginning of the creation of the approach—that you can consolidate or deconsolidate and the balance sheets end up in exactly the same place. The MMT logic holds no matter how you do it: government creates a money of account, imposes a tax in that unit, spends currency denominated in the unit, and collects taxes paid in its own currency.

And, of course, the Fed is not a private institution but rather is a creature of Congress and no more independent of government than is the Treasury, the DOD, the DOT, or the IRS. The Fed is normally allowed to set the overnight interest rate target free from the everyday kind of politics—but all of these other branches of government also have some independence from party politics. Well, the IRS right now is being subjected to some of that.

Anyway, the response was by someone called Calgacus, who often makes quite interesting and thoughtful comments. I thought it would be worthwhile to repost the response here, along with a few comments of my own. The angle taken here on the “consolidation issue” is pretty novel.

In the quotes from Calgacus here, the comment by someone else is in italics, and the response by Calgacus is in normal font. (My comments below are in bold.)

Calgacus said…

The second reason is that Congress does not trust itself to preserve price stability if it avails itself of its inherent authority to issue money directly. So it has accepted a more complex and convoluted system in which only the central bank is permitted to issue dollars, and in which the US Treasury is required to obtain dollar balances by issuing debt instruments and exchanging them for central-bank issued dollars. That is not how it works. Not that it matters, but most state money, reserves is or was issued by the Treasury, not the Fed. There’s some old MMT paper that says 60% or so IIRC. The “money” in the Treasury’s account is not money at all, but the result of a delusion – the delusion of the nonexistent “constraint” that is only said to exist. This “money” is just “one pocket owing another pocket” in Abba Lerner’s words. Nothing would change if a trillion were added to it. The meaningful constraint is the informal upper one on the Treasury account – sopmething like $5B, not the lower one.

The general drift of some further comments is based on this too-usual unconscious construction of money as a thing, rather than a relationship. This results, as usual, in ascribing magical power to the Fed, the supposed magical maker of this magical “thing” – one sort of the nation’s money/debt – the less important sort – reserves. There is even the suggestion that the Fed could win in a showdown with the US Treasury, who makes the more important sort of money – bond debt – or even the Congress, which created and empowered the Fed. What is done here, the common logical error is dissociating the Fed from the Treasury – the left pocket and the right pocket – in one place, but not another. Consolidate or deconsolidate, but decide on which, and then do the accounting. Of course if you change your decision in the middle you can arrive at nonsensical conclusions.

Wray: Exactly right. Choose to consolidate or to deconsolidate and then do your T-accounts and you will reach exactly the same endpoint as long as you stick to one or the other. Not surprising, since Treasury “deposits” at the Fed are internal government record keeping.

It is like you owing your spouse. Your spouse took out the garbage yesterday, so you are in debt. Doesn’t matter to anyone outside your family. Won’t show up on your bank’s balance sheet.

There are all sorts of internal debts and credits within the household, the individual firm, or the federal government. They are of no concern to anyone outside that household, firm or government.

You can deconsolidate the internal accounts of the wife and husband. Wow, the wife is rich—lots of claims on the husband! Their bank won’t be impressed—it will consolidate the accounts and wipe out all the internal credits and debits, which will not show up on their joint account at the bank.

But wait, the husband must get “permission” from the wife before he can write a check on their joint banking account! The bank doesn’t want to hear about that, presuming the husband and wife can work it out.

Internal affairs, similar to the pirouette that the Secretary of the Treasury and the Chairman of the Federal Reserve must engage in to implement Congressionally mandated spending. This should be of no more interest to you, the general public, than whatever it is the one spouse must do to get the other to agree to take the checkbook on a shopping spree.

It amazes me that otherwise sentient economists can get worked up about this.

Calgacus said…

So the Treasury needs to get “money” – “reserves” from the Fed. Fine, we have deconsolidated them. But why is the Fed’s money worth anything at all to anyone? Answer – because the Treasury makes it so. The Treasury exchanges the ready money it invisibly issues for this and only this purpose – and exchanges it at par for the Fed’s reserves. That is one way of thinking of what is going on when the Treasury accepts dollars in its FR account as tax payments terminating debts owed it. That is where the Treasury gets its otherwise worthless reserve balances at the Fed, which are only valuable because they are so backed by the Treasury. Remember, we have deconsolidated. The Fed might as well be the FR Bank of Weimar Zimbabwe, issuing WZFR notes/ reserves. The Fed acts only as a fiscal agent for taxes owed to the Treasury, not it, and when a bank puts tax money in a Fed account, extinguishes its liability to the state by giving money to / drawing down its account at the government’s bank, the Fed, then the bank’s liability to the Treasury is terminated, but the Fed’s liability to the Treasury remains. It needs to be terminated by issuance of Treasury dollars, Treasury credits, the truer money, which the Fed- fiscal-agent can only obtain by putting some Fed funny money in the TGA. In the real world, Treasury debt, US Treasury checks, Treasury money back Fed reserves, NOT vice versa. Fine, if the Fed refuses to cash gubmint checks – then the gubmint sez – I don’t accept FR notes/reserves (at par) for taxes, only direct Treasury debt. Again, consolidate or separate, but do it consistently. Money is a relationship – and who would you like to be in a good odor with, have a positive relationship with, be a creditor, rather than a debtor of – Uncle Sam in DC with his legion of revenooers & henchpeople – or a bunch of snobs educated into ignorance sitting in the Eccles building?

Wray: Nice deconstruction here by Calgacus. The Fed can only issue “fiat money”; the Treasury issues “tax driven money”. Which would you rather tie your fate to?

The Fed is just a bank. It lends its IOUs into existence. Its stand-alone IOUs are desirable only to those who owe the Fed. They can use the Fed’s IOUs to pay down their own IOUs to the Fed. But the Fed cannot force anyone to become a debtor to itself.

The Treasury is the branch of government that is responsible for levying and collecting taxes that Congress has mandated in its legislation. (Technically, yes I know, the IRS is the Treasury’s agent that does this.) Those taxes drive the Treasury’s currency. The Treasury gives value to the Fed’s IOUs (reserves and FRnotes) because it is willing to accept those in tax payment. If the Treasury refused to do so, the Fed’s liabilities would be no better than those of the Bank of Podunk. Without the Treasury standing behind the Fed Bank of Podunk, we’d be back in the 19th century where bank notes did not clear at par.

Our deconsolidators love to believe that it is the Fed that is all-powerful and the poor little Treasury (and by extension Uncle Sam) is subject to the whims of our unelected “private” Fed.

What a load of Malarkey. The Fed is legally a creature of Congress. In times of war or crisis, the Fed is explicitly subjugated to the Treasury. In other times, the Fed serves at the pleasure of Congress and the Treasury albeit with little oversight. While I think that is a mistake, it doesn’t make the Fed either independent or dominant.

What I was trying to do in my own piece was to show that there is a symmetry between the way government spends and the way banks lend. Government needs to spend currency before taxpayers can use currency to pay taxes. Banks need to lend deposits before debtors to banks can repay loans using deposits.

In the past, the government’s treasury alone handled the operations associated with fiscal policy. It literally spent currency and then collected it in taxes. Modern governments have divided responsibilities between the treasury and the government’s bank, the central bank. The government’s bank makes and receives payments for government. Treasury still issues some of the currency, but most of it comes from the central bank (FRnotes).

Most Treasury payments are made by checks or by credits to bank accounts—just like firms and households make most payments by check (or direct deductions).

Central banks have a second function that has come to dominate the thinking of most observers: they are the bank for banks—running the payments system and maintaining par clearing.

These two functions are linked on the balance sheet of the central bank. We could separate out the fiscal policy operations and have the treasury do all of them. The complication is that then private banks would need to have accounts at the treasury—so that treasury could make payments directly to their accounts, and deduct those accounts when taxes are paid.

Banks would still need accounts at the central bank for clearing with each other.

So if we really did “deconsolidate” the Fed and Treasury, banks would have to have accounts at both. It would “work”, but why bother? Why not continue with the Fed acting as the Treasury’s bank, and also as the bankers’ bank?

Oh, but it is just so confusing! You mean the Fed serves two functions? It is the bankers’ bank and the government’s bank?

If economists could get their minds around this, they’d stop worrying about the internal record keeping between the Fed and Treasury. The Fed and Treasury know what they’re doing.

How do we know? Checks are not bouncing and the Fed is hitting its rate target.

If the Treasury’s checks start bouncing, we’ll know it is time for Congress to step in and give Janet a good talking-to.

Until then, I guess the deconsolidators will just need to hold their breath.

23 Responses to To Consolidate or Not To Consolidate, that is the Question (or maybe it isn’t)

  1. A few questions:
    (1) If the government must spend before collecting taxes,
    A. how can the government run a surplus, as occurred during the Clinton administration?
    B. where is the spending if an entrepreneur borrows $10 million, uses the funds to pay wages, the wages are taxed and Uncle Sam collects revenue?

    (2) Loans make deposits but is not that only temporary? Does not the loan have to be eventually repaid from another deposit, wiping out the previous deposit and the created money?
    (3) The Fed prints dollars and repurchases all outstanding public debt. Foreign debt remains ($6 trillion today ). Can the Fed print any more money and could the government approach default if it cannot repay the foreign debt?

    • Auburn Parks

      1) Because there were over $5 trillion in outstanding US Govt dollars held by the non-Govt in savings accounts at the Fed from which to pay AND the private economy could always borrow the US Govt dollars necessary to pay the taxes to the TSY from the Fed. But in either case, it is clear that the funds to pay US Govt dollar taxes must come from the US Govt.

      2) Yes, which is why NET debt is the key data. If more loans are being paid off than taken out, the money supply shrinks and recessions result, If more loans are being taken out than paid off, the money supply expands and we get some increase in economic activity or GDP

      3) The Fed has already “printed” the dollars necessary to “buy” the securities in the first place. There is no foreign “debt” in the way you are using the term. All US Govt dollars are a liability to the US Govt. Whether they be in reserve accounts, cash, or securities accounts is irrelevant to this point. For example, China has $1.2 Trillion in securities accounts at the Fed. If the Fed were to “pay off” that “debt”, all they would do is debit $1.2T worth of securities accounts on its computer and credit $1.2T worth of reserves also on its computer. Either way China possesses $1.2T of US Govt financial liabilities, otherwise known as US Dollars.

      Foreign companies NET sell goods and services to America in exchange for NET US Govt dollars. Once they have the dollars they can do only four things with them:
      1) They can buy more goods and services denominated in US Dollars (which they obviously dont want to do otherwise there would be no trade deficit in the first place)
      2) They can leave them in their reserve accounts at the Fed earning little or no interest
      3) They can transfer them into securities accounts (buy CDs) and earn more interest
      4) They exchange the US Govt dollars for some other countries Govt dollars which would leave the total number of US Govt dollars held by foreigners the same, it would just change the composition of who possesses them

      So there is no “debt” to foreigners that is of concern. China could decide to spend its $1.2 trillion on US Goods and services, and we might get some inflation as it takes time to increase output accordingly, but China doesn’t want a trillion dollars of US made stuff. What they want is to be able to employ over a billion Chinese by having them make stuff and sell it to Americans. China has its own sovereign currency, they dont need our money.

      • I’m unsure if your remarks answer the questions
        (1) Some nations, such as the Emirates have almost no taxes and their currency is well accepted. When Montenegro was part of Serbia, Montenegro accepted only Euros and dollars and did not accept the Serbian currency, but, I imagine, still paid taxes in the Serbian currency. Other nations, such as Romania accepted transactions foreign currencies, but still paid taxes in the Romanian Leu.
        I can also borrow (money created out of thin air) to pay taxes.

        So, the concept that in sovereign nations (not just the U.S.), taxes drive money and government spending comes before taxes, does not seem entirely accurate.

        (2) Yes, loans make deposits but I am unsure if that means the money multiplier does not exist. I believe, but am not sure, that the lending bank must borrow reserves for the new deposits and the Federal Reserve can refuse entry to the discount window. Individual banks can exceed their reserve requirements but the entire banking system is still restrained in their lending (and creation of deposits) by reserve requirements for the entire system, and also by Basle II capital requirements.

        One point of my argument is that deposits made by loans eventually disappear and deposits not made by loans remain. Not that it means anything but it points to what you have correctly highlighted — the failure of the Capitalist system, which survives on debt until credit hits a wall. But not entirely; we have government debt to the rescue and could delay collapse if we had a positive current account balance, which brings purchasing power into the system, just as loans do. Now this something that MMT does not agree with and I believe is wrong thinking.

        (3) I am unaware that foreign governments had accounts at the Federal Reserve. Some national banks, such as China with their 77% owned Industrial Bank, are charted to bank in the United States but that does not mean that the Fed can transfer the sale of their US securities by a keystroke and create reserves. China, in particular, does not disclose what they do with their reserves and where they park them.

        To your chart of how foreign governments use their dollar reserves add:
        Purchase foreign assets,
        Maintain sufficient quantity at home to be available for purchase of their own currency,
        Circulate dollars endlessly around the world, have them never retrieved by the United States, and just grow and grow.

        All this means that the US Treasury and not the Federal Reserve is responsible for supplying the dollars for the purchase of foreign securities. And this has consequences.
        Foreign governments can, with some restrictions, massively purchase our patrimony (land, structures, agriculture, industries, resources) and guide our future.
        Us dollars can leave the 50 states, circulate endlessly, and deprive US markets of purchasing power, a sure route to bust.
        Interest rates can go high in order to retrieve the dollars.
        The government must loan with high interest rates or increase taxes to raise revenue to repatriate the securities.

        I sense MMT refutes these arguments, and I am not convinced by their counter arguments.

        • Auburn Parks

          You’ve got so much wrong in here it would take far more time than I wish to contribute in order to correct the mistakes.

        • danlan,

          “how can the government run a surplus, as occurred during the Clinton administration?”

          It reduces previously issued government debt,

          or the private sector goes into debt to the government.

          • “One point of my argument is that deposits made by loans eventually disappear and deposits not made by loans remain”

            Deposits ARE loans.

            “a positive current account balance, which brings purchasing power into the system, just as loans do. Now this something that MMT does not agree with and I believe is wrong thinking.”

            MMT agrees that a positive current account balance ‘brings purchasing power’ into the domestic economy. However, globally it is impossible for everyone to have a current account surplus at the same time.

            “Interest rates can go high in order to retrieve the dollars. The government must loan with high interest rates or increase taxes to raise revenue to repatriate the securities.”

            Actually interest rates have consistently fallen (all the way to near-zero) as government debt has increased and as the US has run a current account deficit – the exact opposite of what you say should have happened.

  2. “The Fed is just a bank. It lends its IOUs into existence. Its stand-alone IOUs are desirable only to those who owe the Fed.”

    Do legal tender laws not mean that Fed notes, at least, are desirable to those who owe anyone, not just those who owe the Fed?

    • do legal tender laws allow you to override previously-agreed payment terms? If I contract to pay you a certain amount of gold in the future, can I then pay you with dollars instead, and you have to accept the dollars? I genuinely don’t know.

  3. Preaching to the converted I know – but here is an easy set of markers to identify the relationship between the Fed and the rest of government:

    How does the organisation identify itself:
    A big clue is in the name – US FEDERAL Reserve – a direct reference to the level of government to which it belongs and is part of, just like the US FEDERAL Bureau of Investigation. As Prof Wray notes government departments do have a degree of independence within defined boundaries, e.g. the US Census Bureau, in order to maintain confidence in their operations or findings.

    Who appoints the ‘boss’?
    The chair of the Fed is appointed (with a bit of politicking in the process) by POTUS and congress and yes that person may come from within the ranks of the current Fed personnel and selection may be influenced by lobbying from outside (as is everything else that gets decided by the US government).

    Follow the money!
    When the Fed makes a ‘profit’ (i.e. extracts net US dollars from the economy) it does not distribute that to any ‘private shareholders’ but returns what is left after operational costs to the US Treasury. It was about $78B last year and $90B the year before that – relatively small potatoes but not exactly helpful for an economy trying to recover. Furthermore, the activities of the Fed resulting in that ‘profit’ are audited by the US Government Accountability Office, just like other parts of government such as the Department of Defence.

    So what is the big deal with this? The Fed is just another arm of government, with specific duties as specified by legislation regarding the financial system. End of story.

    cheers
    Alex

  4. Professor Wray, this is really one of the clearest explanations I’ve read. Thanks! Here’s a question that may be related–(I’m not sure.) I tore out a Washington Post article this morning–“Treasury moves to expand affordable rental options”–about how the Treasury is planning to issue money directly to local housing authorities to help finance affordable rental housing. The article said this operation would be carried out by the “Federal Financing Bank”–going on to explain that the “Federal Financing Bank” was created by Congress as a “government corporation supervised by the Treasury that is supposed to help federal agencies finance programs at the lowest cost to taxpayers.” Have you ever heard of this FFB, and if so, how might it fit into the operations you’ve described here? Thanks in advance if you have any info.

  5. Always a good idea to get out of the United States for a bit and have a look at what happens in the rest of the world.

    Here in the UK we had a little tussle between a supposedly superior authority and the elected representatives in 1910, when the unelected House of Lords tried to veto the “People’s Budget” set by the House of Commons – the elected house.

    http://en.wikipedia.org/wiki/People's_Budget

    It caused a constitutional crisis and the result was the Parliament Act 1911 – removing the right of the House of Lords to veto finance bills.

    The Treasury implements the will of Congress. Show me somebody in the Fed who will bounce the checks in those circumstances, and I’ll show you somebody looking for a new job in the morning.

    • Neil Wilson said:

      Always a good idea to get out of the United States for a bit and have a look at what happens in the rest of the world.

      Excellent point.

  6. Clonal Antibody

    @danlan When a Government runs a surplus, as happened in the Clinton years, it comes from the non Government Sectors savings. Often these savings are in non cash assets, that have a market value. This market value fluctuates depending on willing buyers at a given price.

    In other words, in order to pay the tax collector, these non liquid assets have to be liquidated, in other words sold for cash. So stocks are sold, physical property is sold, all in order to meet the tax collectors demand.

    So the 2000 stock market crash could well have been triggered by the tax collector’s demands. Too little cash, and too many non liquid assets in the system.

    • “So stocks are sold, physical property is sold, all in order to meet the tax collectors demand.”

      The Fed doesn’t buy stocks or physical property. What must have been sold, to pay the tax, is government bonds (to the Fed).

      • Clonal Antibody

        Philippe,

        Net Net you are correct. However, from the point of view of the individual who owes the taxes, you are incorrect. The net effect of the surplus is to bring down the Dollar amount of the Government bonds outstanding. But before that happens, many dominoes fall. Banks may fail, the stock market may crash, all because of a rush to convert fixed assets to liquid assets.

  7. The Federal Reserve was born in an era when essentially everyone understood that the existing monetary system had to change. And the bankers sold the politicians a new system that was just a tweak or two removed from the first two central banks. But the very important point is that the “new” system was a gold standard system and the uniform currency that was produced by the BEP, the gold certificates, were just paper and they were IOUs, certificates stating that banks owed the bearer x amount of gold. That was all OK but then, 20 years later in 1933, FDR took us off the gold standard. Then the notes printed by BEP became money, not IOUs, and it was still given to banks for free. An equivalent action in the pre-1933 era would have been for the government to have organized a highly professional gold prospecting team to scour the planet for gold and bring it home and give it to banks. I don’t think American citizens would have allowed that to happen but the equivalent of that is SOP in our present fiat monetary system.

  8. Pingback: More on Consolidating or Not | New Economic PerspectivesNew Economic Perspectives

  9. Thanks for the honor of making my comment the subject of this post. Too tired, too late to say more. It was a pleasant surprise to see this. Thanks again, I appreciate it.

  10. This:
    “and who would you like to be in a good odor with, have a positive relationship with, be a creditor, rather than a debtor of – Uncle Sam in DC with his legion of revenooers & henchpeople – or a bunch of snobs educated into ignorance sitting in the Eccles building?”

    -is well said Cal

    I have put it a slightly different way before; Have you ever heard any cries from the people or politicians (cough cough -Ron Paul- cough cough) to END THE TREASURY!!??

  11. Randall,

    danlan raised an important point above. Perhaps you could explain your view on it:

    “Foreign governments can, with some restrictions, massively purchase our patrimony (land, structures, agriculture, industries, resources) and guide our future.”

    This is often considered to be a major issue with running large current account deficits – foreigners can end up owning more and more of your assets (businesses, land etc).

    • Chinese ownership of real estate in the US would be a boon for the current owners. They can’t take it back to China with them and their dollars spend just like ours. Outside of some inflationary pressures on land what could be a real downside to Chinese or any other foreign entity using their dollars to own land?

      I’ll say this. If I bought land in Germany I wouldn’t feel as if I could guide Germany’s future at all. I’d just be hoping to sell it for a profit later No chance China nor anyone else could own enough land here to direct our future. Near impossible it seems to me

  12. Philippe: Yes how did that work out for the Japanese, who bought up NYC and Hawaii back in the good old days when they were the envy of the world, and Americans were shaking in their boots about the Japanese taking over our country. It was “yellow peril” fear mongering. Look, they are subject to our laws. We don’t like what they do with their ownership stake, we change the laws. Oh, and they don’t vote.
    Some worry that at some date in the future the Chinese will want to buy our output, forcing Americans to go to work. We’d suffer the awful fate of full employment and rising wages. The Horror!
    Auburn had some very nice responses here, thanks. Also rightly pointed out that almost all of DanLan’s comments are confused. I agree. At some point, it just is not worth the effort to respond. Would be far better for DanLan to spend a bit of her/his own time to read some of the previous blogs here. And stop just making stuff up!

    • “Americans were shaking in their boots about the Japanese taking over our country. It was “yellow peril” fear mongering. Look, they are subject to our laws. We don’t like what they do with their ownership stake, we change the laws. Oh, and they don’t vote.”

      All very true, but……. and I know you know this, many of the current trade deals being negotiated privately might make the fact that a foreign “owner” doesn’t vote irrelevant. This is why we must remain vigilant to the efforts of “democracy hating capitalists” (not that all capitalists hate democracy, Im simply defining a subset of capitalists) to undermine sovereignty with international trade law. How many of those behind these trade deals would love to see it is that their ownership of land, or any real asset, anywhere, carries the same rights. They don’t want to be troubled with different countries having different levels of tolerance for certain behaviors. If they can pollute in Nicaragua or Estonia, why can’t they pollute in California? The world is different than when Japan was buying up US real estate in the 70s.