By J.D. ALT
What you believe America can build—or rebuild—as a collective society hinges on how you answer one fundamental question: When the U.S. government issues a treasury bond, is it “borrowing” money that must be repaid with future tax-dollars—or is it “creating” money that can be spent to accomplish big and important collective goals?
Getting the right answer to this question could be existentially important. As I’m writing, for example, Hurricane Florence is unleashing historical damage to the U.S. Atlantic coast and inland areas. Over the next weeks and months, the inevitable debate will unfold over how much America can afford to “pay” to make the lives of tens of thousands of families and thousands of local communities whole and functional again. This time, perhaps, the debate will go even further: it might begin to earnestly ask the bigger questions about the future of our coastal cities and infrastructures in an unfolding era of climate change. These bigger questions will not involve billion-dollar budgets, but trillions of dollars of federal expenditures.
This is why my opening question is so important. What we can allow ourselves to do—indeed, what can we pay ourselves to undertake and accomplish as a collective society—depends on the answer.
Before examining the question in more detail, let’s outline the basic puzzle we’re talking about. The U.S. treasury is the spending apparatus of the federal government. Congress democratically agrees upon and tells the treasury what to spend money on, and the treasury duly spends the necessary dollars. If it does not have enough dollars in its tax accounts at the various Federal Reserve banks to meet the expenditures stipulated by Congress, the treasury issues bonds to make up the difference. The bonds are traded (usually to financial institutions) for dollars (bank reserves) which the treasury then uses to pay out the balance of the spending obligations it has been assigned.
This is the common understanding of the puzzle—and the reason most people will initially answer that when the U.S. government issues a treasury bond it is “borrowing” dollars (from the financial institutions who trade for the bond) which must be repaid with future tax-dollars (when the bond matures). What other interpretation could there be? And it’s an interpretation that makes it difficult for America to commit to large, expensive undertakings—such as rebuilding (better and smarter) after a major hurricane, rather than fecklessly dabbing at the wounds (as we’ve done with Katrina, Sandy, Harvey and Maria).
The problem with this “obvious” answer to my question (in addition to the fact that it saddles us with an endless and hopeless austerity) is that, if it were true, the U.S. federal government would not have been able to spend—in real dollars—over $21 TRILLION more, over the years, than it has collected in taxes. For that is, in fact, the case: the national “debt” clock in New York City—which tracks the difference between government spending and tax-collections—currently tallies the number of dollars of over-spending to be $21,477,342,250,762. Are those really dollars the financial institutions “loaned” to the U.S. government? If so, why aren’t they beating the bushes to get paid back? And if they aren’t getting paid back, why do they continue to “loan” such extravagant amounts of dollars to the government? Finally, does anyone really imagine the U.S. government is going to “repay” that vast sum of dollars by collecting taxes? From several different perspectives, then, the common explanations we think make sense don’t add up.
There is another perspective, however—just a slight shift—which causes all the puzzlement to disappear. Not only that, but it is a perspective that clearly makes it possible for us, as a collective society, to undertake and accomplish things we heretofore have not allowed ourselves to pursue, or perhaps even consider.
This alternative framework answers my opening question as follows: When the U.S. government issues a treasury bond it is NOT “borrowing” money but, instead, is “creating” money. It is not incurring a “debt” that must be repaid with future tax revenues but, instead, is “creating” money that can be spent to pay America’s private sector to undertake and accomplish very large, and important, collective goals.
To see how this answer can be valid, visualize a U.S. treasury bond as a container filled with dollars that has a time-lock on it. When the treasury issues the bond, it comes—already filled—with a stipulated number of “future” dollars, and a time-lock with a stipulated date when those dollars can be accessed. When that date arrives, the lock opens, and you (the bond owner) can take out the new dollars and spend them. Until that date arrives, you cannot put your hands on, or spend, the dollars.
Even though you cannot immediately spend the dollars in the bond, it has a “value” that can be traded (if you choose to do so) for dollars you can spend now—but at a discount. This means that if your bond contains, say, 100 “future” dollars, someone might give you only 90 “present” dollars in trade for the bond. They might then choose to hold the bond until the time-lock opens, whereupon they’d remove the 100 dollars—making 10 dollars in profit.
This is essentially what occurs when the U.S. treasury initially issues the bond: It trades the bond (containing a stipulated number of “future” dollars)—typically to a bank or financial institution—for a discounted number of “present” dollars (reserves) which the bank or financial institution owns. The U.S. treasury then uses those “present” dollars it has received in trade to make payments for things which Congress has authorized it to make: it buys goods and services from the private sector, pays federal employees, sends out social security payments, pays local contractors to rebuild hurricane washed-out roads and fallen power-grids, etc. The “present” dollars the treasury has traded its bond for, in other words, are spent back into the private economy and end up in the bank accounts of private citizens and businesses.
When the treasury bond “matures”—i.e. the time-lock on the container opens—the “future” dollars are then removed and become “present” dollars in the private sector economy. We can diagram this process as follows:
Looking at the diagram there are three important things to see:
- The treasury bond operation results in the federal government purchasing goods and services which benefit the good of collective society. In other words, the things that Congress authorizes the treasury to spend dollars on—which causes it to issue treasury bonds—are usually things that the democratic process has determined will benefit society at large. These are the necessary and desirable things that, in general, cannot or won’t be provided by the profit-oriented market economy (for the simple reason they are goods and services that don’t generate profits, or are goods and services needed by citizens who don’t have the financial resources to pay for them—as in disaster relief).
- When the bond matures (and the time-lock opens) there is no need for the U.S. treasury to collect tax-dollars to honor the bond—the dollars are already there. When the time-lock opens, the bond owner simply reaches in and takes them out—or, more often than not, simply uses them to trade, at a discount, for a new treasury bond.
- Thus, the treasury bond operation:
- Creates money which enables the federal government to pay U.S. citizens and businesses to undertake and accomplish large, collective goals.
- The money “created” is not a debt that must be repaid to anyone—and does NOT require the federal government to collect additional tax dollars.
You may object that this is sophistry. How can you create something (money) that doesn’t exist? But remind yourself that the U.S. treasury has, in fact, created—and spent—to date over $21 trillion by this very process. Furthermore, the $21 trillion created and spent thus far now resides in the bank and investment accounts of American families and businesses—and the results of much of that spending are real things that have benefited, and continue to benefit, our collective society: roads, bridges, airports, electric grids, satellite networks, health and science research. (The list could obviously go on and on.) Sophistry does not produce concrete results such as these.
As you watch the aftermath of Hurricane Florence unfold over the next weeks and months—and as you listen to the debate about what America can “afford” to do in response to the overwhelming damage imposed upon East coast families, businesses and communities—and as you read the continued news reports about families in Houston still without housing, or the miserable conditions left unaddressed in Puerto Rico—think about the alternative perspective we’ve just diagrammed.
America is not short of money—or the ability to create it as necessary to pay ourselves to undertake and accomplish our most pressing goals. What America is short of is visionary leadership with a true understanding of modern macro-economics.
If people started taking substantially more money out of bonds when they mature than they rolled over in new bonds, then the Treasury would have to come up with the money to pay off the redeemed bonds. What mechanism would the Treasury use to come up with that new money? I don’t think your answer that the money was already locked away in the bonds is quite sufficient to answer the question.
Yes the Fed could create the money, but under our current laws, how would the Fed get the money to the Treasury? The Fed cannot make loans to the Treasury, nor can it buy Treasury bonds directly from the Treasury. The Treasury would first have to sell the bonds to the public, and as I postulated, the public market had dried up then explain what would have to happen.
Of course the Congress could change the laws. It gets complicated when you try to sneak a little sophistry into the original explanation. If I hadn’t been here to explain this, people would feel that they had been banboozled.
At some rate of return, the Treasury bonds will always be attractive. They always get paid as due. So they will always sell but maybe their effective yields go up (interest rate paid goes up). And the institutions that buy most of the initial Treasuries on auction, the ‘primary dealers’, know very well that the Fed is in the business of controlling interest rates, and will therefore be purchasing them (with a profit for the dealers) if those rates are threatened by the rising yields on the Treasuries. So Congress doesn’t need to change the laws already in place to avoid what you are worried about. The Treasury bonds will always sell and they will always sell at the interest rate the Fed wants them at. That is unless Congress abandons its duty to the Constitution and other laws and decides not to pay them as due. Which isn’t going to happen.
Bonds are offered for sale by the Treasury at auction, with no reserve that I’m aware of. In practice, all bonds offered for sale will be sold at some price. But a bond price implies an interest yield. If that yield is below the Fed’s targets, the Fed will react by buying bonds. No bond trader will refuse to buy bonds if they can turn around and sell them to the Fed for a little profit. I’m handwaving term structures a bit, but in essence a Fed interest target implies support for bond prices.
Even with cartoons you’ve still managed to make things too complex.
Why can you conjure dollars out of thin air? Because the entire concept was created out of thin air I the first place. If you couldn’t conjure them out of thin air it would simply be because you choose not to, not because you cannot.
Replacing the toxic economic ideology we have now with one that continues to obfuscate is not the solution and very dangerous. Still plenty of places to hide tools of oppression. Only by destroying all misleading abstractions will we succeed in throwing off our chains.
The sole purpose of an economy is to provide and protect public goods.
Why can you conjure dollars out of thin air? Because dollars are promissory notes created by the Federal Government, and promissory notes–like all promises–are always conjured out of thin air. Or out of high hopes and good intentions, if you prefer. Incidentally, Treasury bonds are also promissory notes conjured out of thin air by the Federal Government.
You forgot to mention that the discounted number of “present” dollars used to purchase Treasury bonds were created/issued by the Fed anyway. Wouldn’t be better to do away with this farce, and get the Fed to offer interest paying term deposits, if the Fed is required to maintain a non=zero interest rate??
Perhaps the following chart will add some insight to this discussion. Pay no attention to all of those derivatives. After all, what could go wrong?
Steven Greenberg, the money is there because Congress has already authorized the treasury to put it there when it issues the bond. Even if there were no roll-overs, the treasury does not have to collect taxes to make the bonds “good”—the treasury is authorized to continue issuing bonds as necessary to keep the system turning, and if there are no “buyers” for the bonds the treasury issues, the FED is authorized to buy the bonds instead. Thus, the tag-team Treasury-Federal Reserve can always create the “money” as necessary… the net result being that, for all practical purposes, the “future” dollars occupy the bond when it’s issued. The only way they would not be there when the time lock is opened is if, in the meantime, the U.S. sovereign government collapsed. I wish some MMT economists would weigh in on this, by the way—I’m just an architect-writer, not an economist 🙂 I’m interested in debating what this means we can DO as a collective society—not arguing about the detailed mechanics of the Federal Reserve Banking system. The fact of the matter is, by whatever mechanism you want to imagine, the federal government has deficit-spent over $21 trillion and counting—and that is not money it is obligated to repay to anyone: that is money that is already IN the bank and investment accounts of American citizens and businesses. And it is money that paid to make things happen (not all of which, we might agree, were useful—as in, for example, the invasion of Iraq). So, by a continuation of the same process, it seems logical to assume we can create money to pay ourselves to do new things that, hopefully, might be more constructive.
Steve, Sandy, I think you guys got it wrong: The Congress authorizes spending, the Fed credits the Treasuries’ account with the required quantity, the Fed tells the Treasury about the quantity of Reserves to be absorbed out of the system and the pacing – the Treasury Notes remove Reserves from the accounts at the Fed so that the Fed can manipulate the overnight lending rate. Hey Steve, if people don’t want to recycle into new Notes, no problem as long as they don’t put them in the bank-then the Fed would sell notes to the banks. If people wanted to spend, well, then inflation may kick up and the level of taxation would have to increase. None of it is because the Govt needs dollars. It’s about regulating private wealth, production, consumption, interest rates.
I’m with you, Sandy. Even among the proponents of MMT, there are still those who haven’t yet wrapped their minds completely around the full implications of fiat money. Money comes into being, in “let there be light” fashion, purely by federal directives to spend. That’s precisely what “fiat” means, a self-sufficient act or command of will. The artificial linkage of federal spending to bond debt is merely a self-imposed, intentionally-obfuscating accounting system, which makes it appear that the federal government cannot afford programs and policies that benefit the general public, while also bestowing gifts of gratuitous interest to bondholders.
The Fed. can print as much money as the Treasury wants, up to infinity. Large denomination bonds are issued by the Treasury so that only large financial institutions (using the money saved by the fool in the street via his pension fund) can bid for the discounted paper. The fool in the street is thus blocked from getting a fair return on his savings, being paid a paltry interest rate by the bank or having his pension depleted by inflation. This keeps the slaves in “bondage”. The only issue is that if the Fed. conjures up too much Treasury bond-money too quickly, there is a risk of hyperinflation, as in Venezuela. This ponzi scheme eventually explodes because the banks buy too many long treasury bonds in order to exploit the high yields. When the man in the street is out of a job, he finds the bank tied up all his money in long bonds. To meet its short-term liquidity needs, the bank gets bailed out with more Treasury bond money so that the ponzi money-printing scheme can continue to enrich the 1% without risk.
Steven Greenberg, as former Federal Reserve Chairman Alan Greenspan once said under oath, “There is nothing to prevent the government from creating as much money as it wants.” As long as the debt is denominated in US dollars and we have the resources to spend it on where is the problem? That is the power of being a monetary sovereign nation that issues free floating fiat currency. The people we elect to Congress are the ones who have put artificial constraints on how much the government can spend. They have created an environment to enrich their corporate masters and keep the rest of us fighting for our lives.
I am not arguing that the Fed can’t create as much money as it wants to. However, if one is going to write a long article explaining how it works with diagrams and everything, then you might as well try to get the details right. If you are going to use hand-waving arguments, then don’t pretend it is anything else.
Saying things can’t happen just because they haven’t happened yet is not much of an argument. The more the USA uses its control over the dollar as a weapon against other countries, the more likely those other countries will try to find a substitute for the dollar. China, Russia, Middle-Eastern countries, are all working on various schemes to come up with a substitute.
As the USA makes less and less non-military goods and services and the more we have to spend on the military to keep our empire afloat, the closer we get to the day when our economy doesn’t have the capacity to keep itself running. In the end, the value of our currency is supported by a robust economy. We cannot financialize our economy into being strong without the underlying strength to satisfy people’s daily needs.
D. Chekouras – the size of the derivatives market is truly amazing. In 2008/2009 we found out how fast that notional money could disappear in a flash. What probably stops a lot of people from buying MMT is that its proponents often argue that it can’t all collapse because it hasn’t collapsed yet. This is what investors say about all bubbles. The thing that the Fed should have learned by now with all its QR, is something that John Maynard Keynes explained in the 1930s. You can pump all the liquidity into the economy that you want, but if there is nothing worthwhile spending it on, people won’t spend it. Only an entity that is sovereign in its own money can decide to spend money as long as the economy needs the spending to keep it running.
As long as Congress refuses to spend, we won’t get a recovery that puts money into everybody’s hands. The more Congress decides to concentrate the money in the hands of a few, the more precarious our situation becomes. Statistically, this concentration might look good for a while, but eventually a rebellion will ensue.
I too would like for there to be a mmt moderator in attendance to clarify the debates that follow these article written with sincere intent by a layman whom by all account seem to be the only contributor left on this forum. Except for, with appreciative nod to Bill Black whom always reveals the sordid inside job going on in our whacked out system of governance. As such, J.D. Alt to me, has as good if not a better grasp enough of the basic understanding of mmt than the naysayers nit picking his intent. Trying to establish a dialog for the general public’s realizing what is really going on. Not what we’re led to believe. And in theme with a “time lock” for a govt. bond. Joe Carson’s fine country tune, Time Lock, which opened up the door to this heart. https://www.youtube.com/watch?v=_i-tYYbD8us They both pay out reliably, and with interest.
When are the MMT people going to get the right terminology? The Constitution calls these bonds “bills of credit.” Coins are credit instruments, not debt instruments. Same goes for “bills of credit.” Lincoln, with his greenbacks, which he called treasury notes, got the terminology wrong and it took the Supreme Court in the legal tender cases to correct the mistake. But economists never got the memo of the Supreme court’s correction.
It is so easy to get people to understand that you don’t need to borrow or tax to make coins and you can do the very same thing with paper.
Oh dear, this really misses the point. The reason that bond issuance is creating money is that much of the debt is eventually, indirectly, repurchased by the government. Most recently by QE but there are other routes. Issuance of bonds is just a chirade. The government would be best just to create the money directly. Look a Japan to see who owns all its debt (hint, it’s the Japanese government). Read Bill Mitchell’s MMT blog, or read his MMT text book.
About every six months or so, I check in again to see if MMTers have got the legal terminology correct and always the answer is they have not.
If you want to get the concept that the US can not go bankrupt and can issue money without borrowing or taxing you have to use coins as an example, which are not debt instruments, and the paper equivalent of coins, according to the Supreme Court in the legal tender cases is a “bill of credit.” It is not a note or a bond which are debt instruments. In the legal tender cases the Supreme Court held that Lincoln’s greenbacks, though called treasury notes, actually were not notes, because they did not carry interest. Coins do not carry interest and any paper equivalent is a “bill of credit.”
But the government can issue bills of credit and coins without any concern of ever going bankrupt. All these items cost the government is the metal and/or paper cost and the minting or printing charges.
But until MMTers get this terminology down, I think the public will be confused. Lincoln started the confusion, the Supreme Court cleared it up, but economists never got the message.
Here is an explanation that I think will satisfy people who know nothing about Modern Money Theory (MMT), and also satisfy people who think they know everything about MMT.
Why Government Needs to Tax, and Why Government needs to Spend
When you hear MMT proponents hit you with the confusing meme “Taxes don’t fund government spending”, don’t just blow your stack. Read my post, and calm down.