The Explicable Mystery of the National Debt

By J.D. ALT

America’s current “national debt” is tallied to be $21.5 trillion. When politicians and economic pundits talk (worry, fret, wring their hands, gnash their teeth) about this “debt” they implicitly assume—along with their listeners, readers, and potential voters—that this fantastic sum will eventually have to be paid back. That’s what happens with debts, right? Someone calls them due! Everyone also assumes the American tax-payer will have to do the paying. (Quick calculation to save you the trouble: Each one of us is in hock for $65,950!)

Depending on which political football is being tossed around, this “national debt” is either a crisis that must be addressed first (before anything else can be paid for!) or it’s something we can simply ignore for the time being—until the promised “economic growth” comes along that will somehow enable the federal government to collect that extra $65K from each of us. So long as we promise that Yes! someday we’ll pay it off, we can feel okay about going one more day, or month, or year without even starting to do so. In the meantime, of course, the “national debt” somehow keeps growing! At least that must stop, we declare! Our government must stop borrowing even more!

So, we resolve to put a cap on the “national debt.” Which everyone feels good about until the federal government starts running out of tax-dollars to meet the expenses Congress has already committed it to meet. When that happens, the government—or crucial parts of it—painfully shut down. And the fault lies with whoever voted for all that spending in the first place—or whoever voted for all those tax-cuts that made the spending impossible. In the end, after everyone has been thoroughly blamed, the cap on the “national debt” is, of necessity, raised a little higher into the clouds, like Jack’s beanstalk.

Meanwhile, of course, it’s impossible to even discuss the need to spend new dollars to address any of the dire and critical things America confronts as a collective society. We can’t repair our dangerously impaired highway bridges. We can’t modernize our air-traffic control system. We can’t replace our failing, lead-polluted, water-systems. We can’t clean-up the super-fund sites leaching toxins into our ground-water. We can’t provide free pre-school day-care to every mother who wants to secure a job. We can’t modernize and guard from cyber-attack our national electric grid. We can’t provide healthy food and safe accommodations for homeless families. We can’t provide Medicare for every American. We can’t build affordable housing for families earning the minimum wage. We can’t provide a post-high school education for our nation’s workforce. We can’t build modern transit systems that relieve the congestion and gridlock of our urban centers and corridors. We cannot even begin to plan for the relocation and/or rebuilding of millions of square miles of human infrastructure and habitation that will, beginning in the next decades, be flooded by rising sea levels…. There is simply not enough money to even think about doing all these things—and the fact we can’t even begin paying off our “national debt” is a constant reminder of that “reality.”

The mystery is, while all this perpetual haggling and hand-wringing is happening, no one seems to be knocking on America’s door asking to be repaid. Unlike Greece and Italy who are constantly being squeezed by the E.U. central bank and the IMF to repay their debts, no one seems to be squeezing the U.S. at all. Unlike Spain, which gets an earful from Germany if it even whispers about increasing its national borrowing, the U.S. hears nothing from anybody (except its own politicians and pundits) when it votes to raise the beanstalk one cap higher. How can that be? It’s almost as if—weirdly—there isn’t anyone out there expecting to get paid back.

Could that be true?

This puzzlement can, in fact, be explained. More important, the explaining—if you accept the explanation—will change your understanding of what the American economy is capable of accomplishing. And it’s exponentially more than you’d ever imagined.

The mystery lies in the use of the term “borrow.” As it’s commonly understood, when you borrow something, you take temporary possession of it from its owner (the lender)—and when you “repay” what you’ve borrowed, you give it back. What is often not considered in thinking about this transaction is that the lender’s possession is always replaced—either implicitly or explicitly—with a “promise” (i.e. the promise to return the possession, often with an additional premium to compensate the lender for his trouble.)

What is unique about U.S. government “borrowing”—and what gives the term, applied in that context, its confusing ambiguity—is the fact that the “promise” which replaces a borrowed dollar is simply another kind of “dollar.” Specifically, the government borrows a dollar from the economy, and replaces it with a “treasury bond or note” which is, in effect, a special form of “dollars” that earn interest. The treasury bond or note has the same liquidity/tradability in the economy as the regular dollars it has replaced; therefore, the amount of “money” in the private sector doesn’t fall by the amount taken out by the “borrowing” but remains the same as before the “borrowing” occurred.

In conventionally understood “borrowing,” when the borrowed thing is returned, the “promise” that was being held by the lender (either implicitly or explicitly) is simply cancelled. In U.S. government “borrowing,” however, the borrowed thing is NEVER returned because, by logic, the promise being held in its place is already the same thing as what was borrowed. E.g. a $1000 treasury bond is the same “thing” as 1000 dollars—only better, because it earns interest! When the treasury bond “matures,” the dollars it “contains” are simply converted to “regular” dollars or, more often than not, they are rolled into a new treasury bond.

This is why there is nobody squeezing the U.S. government to repay what the government has “borrowed.” They have already been repaid by the treasury bonds they took in exchange for the dollars they “loaned.” (As you can see, the term “loan” applied to this transaction has the same paradoxical ambiguity as the term “borrow.” What’s really happening is that one kind of money is simply being traded for another.)

The surprising result of this transaction is that when the government subsequently spends the “borrowed” dollars back into the economy, there is a net increase in the monetary assets in the private sector equal to the number of dollars “borrowed.” In effect, the treasury bond auction process creates “new” dollars that previously did not exist—dollars which the U.S. government now has possession of and authorization to spend. And that’s exactly what it does: it spends the new dollars to pay for things that Congress has determined will benefit American society.

The consequences of this explanation

First, the U.S. “national debt” is functionally not a debt at all. It is simply a tally of the U.S. treasury bonds which the government has issued and then traded for U.S. dollars which already existed in the private sector. These treasury bonds are in effect interest-paying, time-deposit savings accounts for the bond holders. You personally may have traded some of your retirement dollars for one of these “savings accounts” and you know, firsthand, they definitely contain real money! The “national debt,” then, is really a “national savings account.”

This is, to say the least, a startling and liberating perspective. It means all the political drama and hand-wringing about how we are going to repay our “national debt” can just go away. Even better, all the haggling can be replaced with an entirely different conversation: What shall our government spend the new dollars—created by the treasury bond auction process—to accomplish? The short list of deferred needs, recited earlier, could be a start.

The most extraordinary consequence, however, is that the explanation we’ve just outlined constructs an overarching view of the modern U.S. economy that has never been clear before:

The economy—that is to say, the creation and spending of dollars to undertake and accomplish humanly defined goals—is composed of not one, but two, money-creation processes. The first (and most commonly understood) process is the U.S. banking system: Banks “create” new dollars when they issue loans. This is the engine of American capitalism, and the new dollars sent into circulation by the banking system are specifically (and exclusively) targeted to accomplish goals associated with the generating of personal or corporate financial profits in the market economy.

The second money-creation process, as our explanation above has made clear, is the process we have been habitually calling “government borrowing.” The issuing and auctioning of U.S. treasury bonds, as we’ve just discovered, is not “borrowing” money at all, but creating it. Most important, the dollars generated by this process, which are then spent by the U.S. government, are not spent in the pursuit of personal or corporate financial profits. They are spent to pursue the collective goals—and address the collective needs—of society at large.

The problem we are struggling with today is that while we continue to encourage the first money-creating process—the banking system—to “create” as many dollars as American enterprise and consumers can profitably spend, we have habitually constrained the second money-creating process by labeling it our “national debt” and falsely believing it is encumbering us. In doing so, we severely—and unnecessarily—limit and constrain what we undertake to accomplish for the benefit of what could be called our collective “social economy.” This is a mistake we must now stop making.

Note: I am indebted to Thornton Parker for planting the seed of this essay and, of course, to Warren Mosler who was the first, I believe, to see and understand the true character of sovereign treasury securities.

40 Responses to The Explicable Mystery of the National Debt

  1. You have been a little slippery here, even though I understand MMT (or at least I think I do). Please point out my errors, if any, in the following analysis.

    When people buy treasuries, the money is taken out of the private sector of the economy, and given back to the treasury (government sector) for its use. When the government spends that money into the private economy as deficit spending it is putting the money back into the economy that it took out from the sale of bonds. The balance of spendable money in the private economy is not changed by the deficit spending unless the Fed buys treasuries on the open market thus putting some of that money back into the private economy for immediate spending.

    By the rules that prevent direct transfer of money from the Fed to the Treasury (except for the Fed’s profits), the deficit spending does not become net, fiscally stimulating until the Fed buys some of the Treasuries on the open market.

    • John P Hochbaum III

      “When people buy treasuries, the money is taken out of the private sector of the economy, and given back to the treasury (government sector) for its use.”

      Technically savings is removed from the economy for the use of spending, so this is correct. But treasuries are different because they mature. So they eventually come back into the economy.

      And we have to also consider that treasuries just soak up access savings that would not have been in the economy anyway.So is it really removed? Or is it just transferred from one savings to another?

    • Hey Steven I’m not an expert at MMT but have been listening to many MMT videos and reading many MMT articles for over a year now. I understand the operational reality of securities much differently than you just described but am open to correction from you or some other reader of this thread. Yes, when people buy securities the money is taken out of the economy (private sector) but NOT as you stated given back to the Treasury for it’s use. What is really going on is the person or organization purchasing the government bond simply shifts the money from their Federal Reserve checking account (reserve account) to their Federal Reserve savings account (securities account). This removes the money from the private sector for a certain period of time. The purchaser is agreeing to not spend this money in the private sector for a period of time and receives a little interest for doing so. The Treasury NEVER takes taxes or securities to inject back into the economy. Federal taxes paid are destroyed and purchased securities just sit in a Federal Reserve securities account. With federal taxes paid and securities bought the is money removed from the private sector leaving fiscal space for Congress to come it with it’s spending budget to fill the void with new dollars, thus curbing inflation. Every single dollar that gets injected back into the private sector is keystroked into existence each budget year by the Federal Reserve as instructed by Congress/Treasury Dept.

    • By the rules that prevent direct transfer of money from the Fed to the Treasury (except for the Fed’s profits), the deficit spending does not become net, fiscally stimulating until the Fed buys some of the Treasuries on the open market.

      No. These direct transfer rules are basically meaningless. All (deficit) spending whether in reserves, dollars, coins or bonds is fiscally stimulating. If anything the bonds are more stimulating as they can be used as collateral for private sector lending (multiple times).

      As J. D. says, “the promise being held in its place is already the same thing as what was borrowed. E.g. a $1000 treasury bond is the same “thing” as 1000 dollars”. Or as FDR said, “government credit and government currency are one and the same thing.” (Warren Mosler was not the first; the Mosler MMT contribution is to trace the accounting and logic here in exhaustive and irrefutable detail with clear conceptions and explanations of the big picture & do the same in relating that to the economics proper.)

      The right way to think about it is to lump it all together, bonds + currency = NFA, net financial assets. Treasury bonds are money already. The total of all is the true national debt; which is a debt, but in the more fundamental sense of “moral obligation”. Thinking of the national debt as a financial obligation simply makes no logical sense – that idea is unintelligible world salad with gibberish dressing, as this article points out.

      • Do sector balances not mean anything anymore? I thought the sector balances between government sector, domestic private sector, and foreign sectors were key to understanding vital MMT principles. Do you mean that the use of War Bonds in WWII were not to control inflation? What was the purpose of war bonds then?

  2. James Cooley

    While we are planting seeds and tending our garden, it would be helpful for one of our master gardeners to point out why our “trade deficite” to other countries is not only a false deficite, but actually benefits our whole economy when they accept our paper notes in exchange for real goods and services. Could one of our master gardeners please write an eaasy explaining why this “trade deficite” is no more a burden for our economy as a whole than is my trade deficite to Kroger or Exon Mobile, as long as I earn sufficient income to remain solvent; a problem the fiat currency issuer will never face.

    • I recommend you consult Bill Mitchell’s blog, billy blog, for posts that deal with this topic. He recently posted on this very issue.

      • James Cooley

        I’ll check that out. It would be good to at least see that reprinted here as well.

      • James Cooley

        The information is there alright, but the blog doesn’t clearly address the reasons “trade deficits” are a non issue for sovereign fiat curerency issuers. It is mentioned in passing, but the whole fraudulent nature of trade deficits as a rational for retalieatory teriffs is given short schrift. The public needs to see a clear rejoinder to the tRump smoke and mirrors, not an academic tomb on the size and effects of various countries’ trade deficits.

  3. A very lucid and rational explanation about the misleading way we are programmed to understand Government debt.
    However, the one thing that is not explained is why the Government needs to issue interest-bearing bonds in the first place. If all that is effectively doing is creating new money, why does a Government choose to pay someone else to do what it can do for free? That doesn’t make sense.
    Surely, a Government can devise some practical restraining conditions for creating new money without having to rely on what it can extract from the private sector through bond sales?
    In truth, it is the first and not really the “most commonly understood” method of creating new money through the banking system, that causes most of the problems with inflation and deflation, not the Government, which is the entity that is normally blamed.
    I would also suggest we shouldn’t be promoting the erroneous concept that the Government spends its money for “to pursue the collective goals—and address the collective needs—of society at large” when 1/3 of the budget is spent on warmongering through the Pentagon.

    • Graham Paterson: I think the answer is that for whatever combinations of history and monetary evolution, that is simply the way it’s ended up being done. You’re right, it doesn’t HAVE to be that way, but the important thing is to understand the reality of what’s happening. I would also submit that congresspeople who appropriate dollars for “warmongering” believe they are pursuing a collective goal—and have convinced most of the American people that is the case. That is different than a loan officer approving a bank-loan because they believe the borrower will repay the loan with interest—generating a profit for the bank.

  4. I find it fascinating that one of most radical and prescient thinkers of the 19th Century, Edward Bellamy, envisioned a 21st Century America that had reached a near-utopian state along the lines that MMT now indicates is theoretically within our grasp. Bellamy’s twin masterworks, “Looking Backward” and “Equality,” are freely available on the web should anyone wish to check them out. If one reads nothing else, the opening chapter of “Equality” contains perhaps the greatest Socratic dialogue ever written on capitalism and socialism. Here’s an essay that, unfortunately, fails to do him justice:

    https://newtonfinn.com/

  5. A growing economy can survive with just bank credit dollars until it slows or stops growing. The major shortcoming of this money type is that it cannot retire the debt that created it, so it must either be rolled over into new debt, or retired with the money only Congress can create. It also cannot be net saved, so none of those Treasury bonds represent bank credit, which always nets to zero. We can fool ourselves into thinking we are doing wonderful things with this money, but as soon as the music stops and the fiddler must be paid we find that the only “net” fiscal asset we have is still ol’fashion gubmint dollars.

    • Keith Evans: “We can fool ourselves into thinking we are doing wonderful things with this money…” I think inadvertently you’ve hit the nail on the head! The point of the whole exercise isn’t about the money, it’s about the “wonderful things” we think we’re doing–so long as we actually get them done, and so long as they actually are wonderful.

    • All of this stuff is debt: T-Bills, Treasury Bonds, and dollars. ***ALL*** appears on the books of the Fed as a liability. It’s bank debt, not household debt.

      Your checking account is your asset, but the bank’s liability. Ditto for your savings account. When you write a check, you’re assigning a portion of the bank’s debt to the payee. Dollars are simply checks made out to cash in fixed amounts.

      How many dollar financial assets are in circulation in the U.S. economy? Exactly the amount we call “National Debt.”

      And how often do you hear of bank’s depositors petitioning the bank to diminish its indebtedness (i.e. the amount in their accounts) by increasing its fees or lowering interest paid on savings? That would only occur at the bank of crazy people.

      Meanwhile, what do dollars really indicate? They are an IOU. What is owed? A dollar’s worth of relief from an inevitable liability: taxes. That’s right, taxes make the money valuable. They do not fund or provision the government that makes the money (where would tax payers get dollars to pay taxes if the government didn’t spend them out into the economy first?).

      What does China get for its dollars? The right to buy things with dollars. That’s it. And even that is not an unrestricted right (remember, government can forbid certain transactions). Steve Keen says MMT ignores the real import of balance of payment imbalance because it’s too U.S.-centered. Meanwhile, if we’re to remain the world’s reserve currency, the U.S. *must* run a trade deficit so it can leave dollars in the hands of its trading partners.

  6. John Zelnicker

    J. D. – You have done a great job over the years of coming up with a variety of ways to address the public’s misunderstanding of our fiat money system and it’s components. I consider Diagrams & Dollars to be a masterpiece.

    This post is another keeper. Thank you.

  7. It’s just like buying a CD from your bank, and paying for it out of your checking account. Nobody thinks that the bank is “borrowing” anything. The bank is just exchanging one kind of promissory note (CD) for another kind of promissory note (checking deposit). Both are promissory notes (liabilities) of the bank. The CD purchase does not increase the bank’s total liability, therefore no “borrowing” occurred.

    Similarly, sale of a Treasury bond is just an exchange of one kind of Government promissory note( liability, currency or reserves) for another kind of Government promissory note (liability, T bond). Total Government liability does not increase, therefore no “borrowing” occurred.

    If you borrow your neighbor’s lawnmower, your liability increases by one lawnmower. That increase in liability is the hallmark of borrowing. If you trade your snowblower for his lawnmower, your liability does not increase, because it was not borrowing, it was a trade or swap.

    Treasury bond sales are a swap of assets (from the private sector’s POV) or liabilities (from the Governments POV). As with lawnmowers and snowblowers, with a swap there’s no borrow.

    • Dave Paulson

      Nice! I don’t know why I never made the comparison myself, but the synapses are now connected.

  8. How do future-year unfunded liabilities, such as SS, Medicare, etc., fit into this explanation?

    • John Zelnicker

      @James – August 2, 2018 at 7:38 am
      ——
      The term “unfunded liabilities” is misleading. It is used by those who do not understand sovereign fiat money systems like ours, mostly as a scare tactic.

      All Social Security and Medicare, as well as any other government “liabilities”, are paid when due by someone entering instructions into a computer telling a bank to increase the balance in the target person’s or company’s bank account. (The Social Security Trust Funds are an accounting artifice that don’t have anything to do with the payment of benefits.)

      There is no reason, other than politics, why the government cannot continue to pay SS and Medicare benefits in the same fashion when they come due in the future.

  9. Did you find cgordon’s response answered your question, Mr Greenberg? I think he’s got it right.

    Also, in response to Greenberg’s comment:

    “By the rules that prevent direct transfer of money from the Fed to the Treasury (except for the Fed’s profits), the deficit spending does not become net, fiscally stimulating until the Fed buys some of the Treasuries on the open market.”

    Treasuries notes and bonds are extremely liquid, and will be accepted by the central bank as collateral. So no one is unable to spend in any serious fashion because they hold their money in the form of Treasuries (time deposit) as opposed to cash (demand deposit).

    Also (thanks to https://www.investopedia.com/university/moneymarket/moneymarket7.asp for the quote), there are money markets which swap interest bearing money for demand deposits as needed, so that cash is readily available when desired for those who hold geovernment notes/bonds:

    Repo is short for repurchase agreement. Those who deal in government securities use repos as a form of overnight borrowing. A dealer or other holder of government securities (usually T-bills) sells the securities to a lender and agrees to repurchase them at an agreed future date at an agreed price. They are usually very short-term, from overnight to 30 days or more. This short-term maturity and government backing means repos provide lenders with extremely low risk.

  10. William Beyer, FAIA

    Very nicely written and reasoned, J.D! My fallback argument is that you don’t “borrow” your own money, money that we the people have specifically empowered our government to create. The word “borrow” is an Orwellian abuse of the language, as Jamie Galbraith has said, “to fool the rubes back home.”

  11. What was that comment about “Does the bowling alley run out of points”?

  12. Kelly Gerling

    Dear JD,

    Thank you for the superb article.

    You said that there are two forms of money creation in the American economy: bank loans and issuing treasury bonds.

    Is there not a third form of money creation?

    Is spending by the national government for infrastructure like creating and maintaining the Interstate Highway System, paying Social Security benefits, paying into some kind of future universal job guarantee or UJG, paying salaries of federal employees, paying for military equipment and Pentagon salaries, etc., money creation?

    Aren’t those on that list, and many others, paid for by the national government crediting accounts according to allocations authorized by the government in a budget?

  13. I was a little loose with some of my words. I should have said that:

    When people buy treasuries, the money is taken out of the private sector of the economy, and given back to the treasury (government sector). When the government spends the same amount of money into the private economy as deficit spending it is putting this amount of money back into the economy that it took out from the sale of bonds. The balance of spendable money in the private economy is not changed by the deficit spending unless the Fed buys treasuries on the open market thus putting some of that money back into the private economy for immediate spending.

    For me, the above rewrite is a distinction without a difference for what I am talking about. However in some other situations it might be important, and MMTers think it is always necessary to be emphasize this detail. My being careless with the words only got in the way of the point I was making.

    The fact that the purchaser of the bond cannot spend that money until the bond matures is of great significance. War bonds were sold during WW II to get money out of the hands of workers so that they could not spend it while factories were devoting all their efforts to making military items. The point is that the bonds would be redeemed after the war was over, and the factories could provide for consumer demand. In other words war bonds were sold to control inflation, not to finance the war.

  14. It is the purchase of the bond from the government that transfers money from the private sector to the government sector. Trading bonds in the private sector does not change the amount of money in the private sector. It just shifts the money around inside the private sector.

    • Steven, the way I think of this is that there are three kinds of money issued by the Government: paper money and coins (walking around money), reserve dollars (checking account money), and Treasury securities (savings account money). All three are promissory notes (liabilities) created out of thin air by the Government. Others have noted here that as a practical matter all three kinds of money are freely convertible into the other kinds. So to say that bond sales remove money from the private sector isn’t really appropriate. They do remove reserves from the private sector, which tends to push up interest rates on reserves (the Fed funds rate). And control of the Fed funds rate is the real purpose of bond sales.

  15. Also remember that private sector money that was in a bank account could have been lent out by the banks in the form of loans. If someone taps their savings account to buy a government bond, then that money is removed from the private bank (and the private sector). The private bank will have to do something about that loss of deposits, which could have multpilier effect on the amount of money that seems to be circulating in the private secrtor. Money transferred from the private sector to the government sector just disappears until a similar amount of money is put back into the private sector by the government.

    • Steven, I don’t see Government bond sales as a transfer of money. It’s a swap of one kind of promissory note (reserves) created by the Government out of thin air for another kind of promissory note (bonds) created by the government out of thin air. These things are, as has been noted, for all practical purposes equally liquid; they are both money. What does change when the Government sells a bond is that reserves are drained out of the banking system, and the interbank rate on reserves (Fed Funds rate) goes up a bit. At the end of the day, interest rate manipulation is the point of bond sales. The only way to make Government money disappear is taxation.

  16. terrymcneely

    I found the explanation rather roundabout and confusing. But this is my understanding of what MMT is getting at:as i understand it, we can’t just print dollars to spend cause treasury’s hands are tied and you have to go to the Fed to hold an auction of treasuries first to print the money you will use to pay off the old treasuries, in essence the debt rolls over. It looks like, if my understanding correct, you can’t pay off the “national debt’ because the Fed Reserve Act prevents it.
    But if this is correct this is also how the national debt was created in the first place, if my thinking on this is correct/
    Wray in his book on modern monetary theory states that the Treasury has its hand tied by the FRAct in the first place; any spending has to be preceded by going into debt, selling a treasury bond; an unnecessary and complicating step, except lots of people do want to own treasuries as a safe place to park their money. mahalo.

    • All of this stuff is debt: T-Bills, Treasury Bonds, and dollars. ***ALL*** appears on the books of the Fed as a liability. It’s bank debt, not household debt.

      Your checking account is your asset, but the bank’s liability. Ditto for your savings account. When you write a check, you’re assigning a portion of the bank’s debt to the payee. Dollars are simply checks made out to cash in fixed amounts.

      How many dollar financial assets are in circulation in the U.S. economy? Exactly the amount we call “National Debt.” We circulate a bunch of IOUs as our medium of exchange.

      And how often do you hear of bank’s depositors petitioning the bank to diminish its indebtedness (i.e. the amount in their accounts) by increasing its fees or lowering interest paid on savings? That would only occur at the bank of crazy people.

  17. Micky9finger

    Bill Mitchell teaches there is absolutly no reason to sell bonds except as corporate welfare.

  18. The FED Funds Rate is the interbank loan rate. It is not the interest rate of bonds.

    The impact of the freely convertible depends on where the conversion happens. Once the money is given to the government sector to buy bonds for the private sector all conversion of those bonds happens in the private sector. So the money that is already in the private sector could be the money that is used to swap someones bonds for someone else’s money. The swap involving the government sector again only occurs if the bonds mature and are redeemed or if the FED should buy treasury bonds in the open market. If you want to preserve the idea of sector balances that is so important to MMT, you must differentiate between swaps that involve the government sector and the ones that do not involve the government sector. It has nothing to do with how you look at it. It only has to do with the explanation of all this that is part of MMT. Either you agree that MMT is an accurate description of how money works, or you don’t.

    • The Fed funds rate is the interbank loan rate on reserves. When the Fed wants this rate to go up, it sells Treasury securities, accepting payment in reserve dollars. That drains reserves out of the banking system and tends to push the rate up. If the Treasury didn’t sell securities, it wouldn’t be possible for the Fed to control interbank rates on reserves. (I suppose the Fed could buy some other bank asset, but it typically doesn’t. The other way to control the interbank rate is to offer interest on reserves. The Fed does do this now, I think, because QE flooded the banking system with reserves.)

      What MMT does say is that demand for credit in the banking system controls the money supply (not, as often claimed, with the money supply determining the supply of credit through a money multiplier mechanism). More specifically, when banks expand credit (by creating deposits), reserve requirements go up. That would tend to push up the Fed funds rate, forcing the Fed to buy Treasuries which releases reserves and pushing the rate back down to its target. So it’s more correct to say that demand for credit in the banking system controls the supply of reserves.

      Swaps between buyers and sellers in the private sector don’t, as you point out, directly affect the supply of reserves. But overall demand for reserves to meet reserve requirements forces the Fed’s hand, as noted in the last paragraph. That is the basis for my claim that bonds are in practice freely convertible into reserves.

  19. Does Bill Mitchell ever discuss the use of bonds to control inflation?

  20. I tend to like Gary Houk’s description earlier in the comments. To suggest that treasury sales make money available for federal spending almost seems akin to suggesting that banks loan deposits. The Treasury General Account which is credited with tax collections and treasuries sales and debited with federal spending is an artificial and pretty meaningless constraint, I think. It is useful for record-keeping, I suppose, but does it contain dollars in any form? No. Could the Treasury carry on its operations without it? Of course.

  21. “The treasury bond or note has the same liquidity/tradability in the economy as the regular dollars it has replaced; therefore, the amount of “money” in the private sector doesn’t fall by the amount taken out by the “borrowing” but remains the same as before the “borrowing” occurred.”

    However, treasuries do not show up in any money supply measure do they? Is it not true that treasuries sales drain reserves and possibly reduce bank deposits as well, thus leaving a smaller MB money supply and possibly a correspondingly smaller M1 money supply? Does that not signal that there is, in fact, less “money” in the private sector — at least until the the treasuries expire and the reserves and possible bank deposits are restored? Or is that measure passe? It seems to me that the only way a treasury can be converted back to “money” of any standard measure prior to its expiration date is for the Fed to purchase it, and even then it just restores reserves doesn’t it?

  22. cgordon, I just read Chapter 18 of Michael Hudson’s book “Killing The Host: How Financial Parasites and Debt Bondage Destroy the Global Economy” It finally drove home to me the real and significant difference between money created by the FED and money created by a private bank. When the federal government spends FED created money into the economy, it is debt free to the recipient. When a bank lends money, the loan comes with an interest burden to the recipient. It is that additional interest burden that comes from the loan for every round of circulation through the private banking system that is a burden on the private sector of the economy that does not exist with money spent into the economy.

    In all my years of reading about MMT, that point never dawned on me. MMT talks about high powered money and private bank created money, but it seemed like a distinction without a difference. I wished that these MMT explanations had just said that the interest owed to the bank was the issue.

  23. Jim Gaddis, see my comment about the difference between bank created money and FED created money. When the federal government spends money into the private sector of the economy, there is no debt owed by the recipient of that money. Each time money is deposited in a private bank, and then loaned out in a new loan, there is an interest burden put on that loan that the customer takes out. For the bank to make money, the interest it charges is higher than the interest it pays to the depositor of that money. That interest differential is a burden on the private sector borrowers that extracts money from the borrower and transfers it to the FIRE sector of the economy (Finance, Insurance, and Real Estate). It is the transfer of money from the 99% to the 1% in this bank transaction that builds up, and is a drag on the economy.