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Dan Kervick's picture

Why Does Uncle Sam Borrow?

The Unites States government operates a fiat currency system.  The government is therefore the monopoly supplier of the final means of payment in our dollar-based economy, and is ultimately responsible, in one way or another, for any net increase in dollar-denominated financial assets in the private sector.

And yet, we continue to hear bipartisan expressions of fear and angst about the budget deficit and the national debt.  Both major parties seemingly agree that we are “out of money”.   They wrangle over various competing approaches to shrinking the gap between tax revenues and government spending.  They appoint commissions to study the government budget and recommend some combination of slashed spending and higher taxes in order to close that budgetary gap.   They warn us that we will transform ourselves into banana republic status if we do not urgently address our public debt problems.

This situation should be perplexing.  Why does a government that is the issuer of the national currency have to borrow that currency back from the public to which the currency is issued?   And how could such a government ever experience the kinds of budgetary squeezes and debt burdens that can pose severe problems for households and businesses?

I wish to make a radical suggestion:  Public borrowing is an outdated practice, and we could dispense with it entirely.

Borrowing by the public treasury and the accumulation of government debt obligations are legacies of the era that preceded the development of modern fiat currency, an era when governments were primarily users of traditional means of payment that lay outside their control, and not the producers and issuers of the primary means of payment. That pre-fiat era is now dead in the US, and the chief remaining role of government borrowing in our time is to bamboozle the public, and to obscure the true nature and effects of government fiscal and monetary operations under a bewildering maze of bookkeeping ink and financial legerdemain.

Eliminating public borrowing, and replacing it with operations that are simpler, more direct and more transparent, would advance the cause of informed democratic debate over public spending and taxation.  Above all, the change would eliminate needless obscurity and confusion and help us all understand exactly whose bread is being buttered by the budgetary decisions made by politicians.

[Read the rest at New Economic Perspectives.]

I really wish you had taken this in the opposite direction.  Money is public debt; public debt is money.  I have seen MMT arguments making that point.  It is a valid one.

It would be better to teach people not to fear the debt than to attempt to reframe redefine it just because it is being used by political opponents to fear-monger.  They risk undermining general confidence in the dollar as do you and other overly avid MMTers when you advocate such radical changes in response.

MMT is making inroads.  Be careful not to lose the gains through impatience.  

 

I'm not sure it clarifies matters to think of money as public debt.  The sense in which that is true is that money extinguishes tax obligations.  But if you have paid your taxes, then the money you possess doesn't entitle you to anything more.  You can expect to be able to exchange it for something else.  But that expectation isn't grounded in the fact that the money is a <i>claim</i> on something to which you are entitled.  If all money were debt, then juts by virtue of the fact that you hold that money, someone would owe you something.

I think Emma is conflating the monetization of our public debt undertaken by Hamilton with the way that federal debt is now empowered to magically multiply itself on the books of member banks through the miracle of the loaves and fishes fractional reserve banking.

Hamilton was operating in a world of specie money, and trying to create a store of value that could become an agreed upon basis for commerce other than specie.

Today, in an all fiat world, the monetization of debt is unnecessary and counterproductive, as it brings into play political forces that undermine the public weal.

I think Emma is conflating the monetization of our public debt undertaken by Hamilton with the way that federal debt is now empowered to magically multiply itself on the books of member banks through the miracle of the loaves and fishes fractional reserve banking.

​No, not.   See above reply to Dan.

I knew I should not have inserted public as an adjective.  I only did it because the the only way we currently think of money is as public money but even the private money of pre-Fed banks was debt.  The banks, acting as clearinghouse, issued notes that they were obliged to honor ... or die.  

Think of government the same way.  It is a clearinghouse, inefficient, extremely laissez-faire and presently designed to benefit 'wealth' holders.  It is obliged to honor its notes whether currency or bonds,

Try this thought experiment.  Imagine you are king, an absolute monarch but without any specie.  After much angst you eventually realize you do not need actual specie which is really only a symbol for money anyway.  

In order to induce your subjects to exchange information, goods, services with one another, you promise to credit them appropriate amounts in your ledger.  You then give them receipts for those amounts which can be exchanged among themselves.  Those receipts are your iou's, your debts, and your subjects' money.   

I know you know all this but I do not think you are seeing the truly astonishing possibilities of thinking of or simply recognizing the government as clearinghouse and banker.  One of the possibilities opened by our recent interconnectivity is eliminating the vig JR resents paying to those once essential middlemen, the NY banks.   They are obsolete and know it. And wow are they ever going to fight it. 

It is obliged to honor its notes whether currency or bonds,

Obliged to honor them with what Emma?  The only thing a Federal Reserve note entitles you to is either a discharge of a tax obligation or an equal quantity of the very same notes if you decide to trade them in.  They are not like the banker's credit which is convertible into demand into either gold (olden days) or the government currency (today).  The public currency is the end of the line.  If you have received that currency in payment of a debt you have no legal entitlement to convert the currency into something else.  There is nothing to honor.  If the government owes you something and gives you notes in payment, then it has already honored its debt.  There is nothing further it has to do to honor the notes.

Yes, we could definitely get rid of private sector banks if we want to.  We could turn the entire banking system into a not-for-profit public utility, and cut out many layers of middlemen.

The public currency is the end of the line.  If you have received that currency in payment of a debt you have no legal entitlement to convert the currency into something else.  

​Remember in this thought experiment you are king.  If you have nothing with which to redeem the notes, you have been a very bad king.  Well, that happens. You just have to refinance and hope you get to keep your head and crown.

​If you have been a really good king, then your notes are the most desirable financial instrument on the planet and no one will want to cash out.   Just like the dollar and Tsys are now.  Hopefully as a good king, the prosperity of your kingdom is more broadly based than at present.

You do not have to get rid of private banks to have one as a public utility but you can stop subsidizing them with agencies and regulations.  Each side could benefit from the competition.  What's that called?  Countervailing forces?

 

Sorry Emma, but I don't know what you are suggesting.  Are you saying that for dollars and Treasuries to be desirable they have to be redeemable?  Redeemable into what exactly?

I probably should have said exchangeable instead of redeemable.

Money is the medium of, not the actual exchange.  It allows us to go beyond barter and enables us to span distance and time in our exchanges.  But for money to work you have to have honest brokers, someone or something you trust to act as a clearinghouse to make good on your exchanges.   

Not exactly the same but if you read how the stock and commodity exchanges came to be, it probably explains the idea better than I can.  The major players devised the exchanges to act as a third party so they did not have to wonder whether they could trust each other on every transaction.  If one of them did not play by the rules of the exchange, they got penalized and/or booted.

Oh, and the Federal Reserve is actually a clearinghouse between banks.  I thought it was interesting that one of, if not the, first things Bernanke did after the Fall of 2008, was to promote a clearinghouse for repo transactions.  That was a major clue of what went wrong.  It amazed me that none of the economists I was reading at the time noted its significance.  

 

I rank first among his many punkish tells, the failure of Prez to seize upon the gordian coin seignorage solution to the debt limit knot.

It is pure MMT, raises no constitutional spilkes a la a fourteenth amendment runaround of congress, and it is unassailable.

Hell, if you don't like the 6 trillion dollar coin, how bout ten trillion one dollar coins.  they cost thirty five cents to make, that's easy money.  By my math, those stamping machines should be smokin 24/7, when they are done we have 6.5 trillion to use on that howwible, dweadful, debt.

 

The only debt limit I believe in the the maxed out production capacity of the entire country.  All others are just arbitrary lines in the sand for political posturing.

 

The "debt limit" used to be the House voting "no" on an appropriation...

 political posturing.

​As to that there are two kinds.  The Pete Peterson school, where it's " debt is strong arm robbery of the next generation, don't give granny that scooter."..  

 

But worse is that rattlesnake, Obama, where he manufactures a debt crisis so he can stab his base in the back and deny responsibility.


 

This is a trick question, right?

If we didn't borrow, how would the banks earn a safe three percent  vigorish spread on lending us our own money?

I have a very funny little pamphlet from 2000 by a Dr. Albert M. Wojnilower, which was distributed to Goldman Sachs clients in the spring of 2000.  You can download it here.  I keep a physical copy because it amuses me to think that back when Clinton was leaving office, it was of major concern to the financial industry that the U.S. was going to generate surpluses forever and stop issuing bonds.  Heck, by the time Clinton had left office, the U.S. had already stopped issuing 30 year debt.  That's amazing.  The next President, of course, "fixed" the problem.  But we were on course to do what Dan is saying.

The problem is, this would have eventually deprived the world of a "safe" place to store reserves.  There are no pan-national "euro" bonds and, as we've learned, the Euro zone has not rendered Euro-country bonds safe.  Because Britain and Japan control their own central banks, their sovereign debt is "safe" in the sense that there can be no real default risk unless they import Republicans and the idea of a debt ceiling.  But neither of those economies are large enough, or liquid enough, to absorb the wash of currency reserves from exporting nations.

That leaves gold.  But there isn't enough gold in the world, either.  Wojnilower described the debt as a "public good."  In a sense, it really is.

there can be no real default risk unless they import Republicans and the idea of a debt ceiling.  

tres funny.

Thanks for the link.

Destor, just a few quick reactions:

Not borrowing is not the same thing as running surpluses.  A government that issues its own currency can do something that a household or business cannot do: run a "pure" deficit.  It can simply spend more than it takes in, without issuing debt to cover the gap.  Government spending injects money into the private sector and taxation extinguishes money from the private sector.  You can think of this as "printing money", but in general it just means that the net amount credited to private sector accounts by the government is greater than the net amount debited from private sector accounts.

The Clinton surplus was probably not a good thing.  It preceded a recession and may have been part of the cause of that recession.  A situation in the government is creating less money than it extinguishes is a contractionary situation.  The size of the annual deficit needs to be managed for the sake of price stability, but there should probably be a permanent deficit at almost all times. 

It might be that one aspect of government borrowing performs a public service in supplying low-risk savings vehicles.  This claim has been made since at least the 18th century as part of debates on public credit and government debt.  Fine.  We can view the central bank as the apex of big savings institution for parking cash reserves and  minimizing inflation risk.  Then let the central bank issue securities.  But we can do that without conveying the impression to the public that the treasury needs to borrow to carry out spending.

If the goal is to increase people's understanding of what's going on, then what I think has to happen is that politicians have to change their rhetoric.  Both Democrats and Republicans really are equally to blame for describing the nation's finances in colloquial terms such as "family budgets," and "credit card bills," or for saying lame things like, "if you ran your business the way the government ran its finances, you'd be out of business." 

I know I'm off on a tangent here, but our leaders have basically infantilized the American public on this issue.  I'd say that the facts of the U.S. government's ability to control the supply of its own currency and what that means should be taught in schools but I think you'd find very few people capable of teaching it.

Thanks, Dan. These MMT articles are always interesting and edifying.

I think that I understand you point with respect to domestic dealers. Since the Fed must ensure roughly consistent reserves over time (as a percentage of GDP), it has to compensate public borrowing by replacing the dealers' depleted reserves. In that case, you could theoretically eliminate the dealers without increasing the total money supply--or at least without increasing it any faster than current deficit levels cause us to. Is that more-or-less accurate?

But foreign dealers aren't backed by the Fed. They're backed by their own central banks. If Canadian banks buy a lot of American debt, it's the Bank of Canada's job to ensure that they have sufficient reserves. Or the Bank of Canada might buy our bonds directly.

So if you eliminate the foreign dealers, you're not just shuffling the chairs. You're actually cutting off a revenue source that would have to be replaced by expanding the money supply beyond what is already happening, and that could presumably be inflationary.

I suppose that another way to think about it is within the current monetary system. If Congress passed a law that prohibited foreign debt, what would be the economic impact?

So if you eliminate the foreign dealers, you're not just shuffling the chairs. You're actually cutting off a revenue source that would have to be replaced by expanding the money supply beyond what is already happening, and that could presumably be inflationary.

I'm not sure, Genghis.  It seems to me that if a foreign national buys US treasury debt, they buy it with dollars.  Those dollars already exist as deposit balances in some US-based account, and buying the debt is similar to moving dollars from a checking account to an interest-bearing savings account.  The central bank of a foreign country can't create dollars, so all of these transactions involve movements of dollars within the "dollar zone".  So isn't this just a question of whether the owner of the account is named "John Smith" or "Wen Bo"?

The money supply is almost always increasing, since the size of the economy is nearly always increasing.  So one question is what channels we want to use for making net injections of money into the economy.

I don't think that's true, is it? Buying U.S. securities is how they get dollar reserves. They don't exchange their currency for actual dollars and then use those to buy the securities. (And even if they did, it shouldn't make a difference.)

The point of your piece, I thought, is that John Smith's bond purchase makes no real difference because the Fed essentially buys back the debt by giving loans to Smith. The balance just switches quietly from public to private and back to public.

But the Fed doesn't give loans to Wen Bo. China does. So unlike Smith, his investments really affect the overall economy.

I think my central point was just that the US government, which effectively includes the Fed, is the monopoly producer of the US dollar.  Every additional dollar that comes into existence does so in one way or another because the US government issues it or concurs with its issuance.  The only sense in which the government needs to "raise" dollars through borrowing or taxation is that it voluntarily chooses, for the sake of price stability, to move certain quantities of dollars from private accounts to public accounts, rather than simply create additional dollars for its own use.

It's not so much that the Fed gives loans to Smith, although it can do that too.  It just buys things outright from Smith. Smith gives the Treasury $995 in exchange for a T-bill worth $1000.  Smith then sells the T-bill to the Fed for, let's say, $998.  The Treasury then pays the Fed the $1000 it owes on the bill, and the Fed returns the $5 in interest to the Treasury.  The net effect on the Treasury account is $0.  Smith is $3 richer, and the Fed books a $3 debit to its own account.  But this debit or "liability" isn't some kind of draw down on the Fed's finite stock of dollars.   The Fed doesn't have to first acquire that dollar elsewhere.  It creates it from scratch.

It's not like we are on a gold standard where the Chinese might hoard the common global medium of exchange and deprive us of access to it..  We can't be dependent on the Chinese to supply us with an entity of which we are the monopoly producer.  The government can create dollars in massive quantities if needed by marking up accounts electronically.  The only think we are dependent on the Chinese for are the actual goods and services we want to buy from them, and the Chinese currency we might use to buy those things.

Maybe I'm misunderstanding then. Why does the Fed buy the T-Bill from Smith?

Because, in our case, Smith is Dimon, and the Fed works for him.

 

Dimon wants a risk free spread when he comes with his fractional reserve magic money.

So what about Wen Bo? He's not Dimon, or at least not Armon. Why would the Fed buy his T-Bills?

Same thing.  Wen Bo's Treasury securities are held in an account and correspond to a set, predetermined schedule of interest payments to that account.  By substituting an immediate payment of dollars now for the delayed schedule of payments later, the Fed can reduce the FF rate.  Similarly, it can sell Treasuries back to the private sector to raise the FF rate.  Also, coordinated action between the Treasury and the Fed on the sale and repurchase of securities of different durations could help achieve some exchange rate target.

What would happen if the Chinese decided to stop exchanging their dollars for securities?  It would be like they had decided to keep all of their money in checking accounts and stop moving some of it into savings accounts.  They are then losing money, but presumably they would then start spending a higher proportion of it, which is the usual reason people start holding more money in checking.  As they spent it, it  would move into other US bank accounts and keeps the quantity of reserves high and the FF rate low.

If they decided not to spend it but to hold it, that would create upward pressure on interest rates, including for Treasury securities.   But the Fed could then flood the US system with additional reserves to offset the held Chinese dollar sums that are not circulating, and bring interest rates and US government borrowing costs back down.  If the Chinese then later start spending their held reserves into the system, the Fed can drain reserves to help preserve price stability.

Note that the Eurozone nations lack some of these powers because they no longer control their own currency.  If their government's borrowing costs go up, they cannot inject more Euro reserves into the system to bring those costs back down.

It doesn't.  Wen Bo parks his accumulated cash in Treasury and Agency repos through one of the Fed's Primary Dealers or some other agent further down the food chain.  

Did you know that China had about $400 billion in Fannie Mae and Freddie Mac bonds or repos when things went south in 2008 which is amazingly almost the same amount that Congress paid to bail those agencies out.

Makes a person wonder if there are money wars afoot.  

It buys the T-bill from Smith to manage the Fed Funds rate, the key financial industry interest rate that banks charge one another for interbank loans.  If Smith and others have bonds that they paid $980 million for last week, and are going to deliver $1 billion dollars to them one year from now, they will probably be willing to sell them to the Fed $990 million now.  That means the government has substituted an immediate-term injection of $990 million for a larger injection of $1 billion one year from now.  The effect is to add $990 million to bank reserves right now, which brings down the current Fed Funds rate of interest banks charge for loans of reserves.   Since the rate of interest banks charge their customers is related to the rate that they have to pay for additional reserves, the decrease in the Fed Funds rate should be stimulative.

Unfortunately, now that we are at the zero-bound, there is little the Fed can do any more through these kinds of open market operations, "quantitative easing" etc.

Thanks, Dan. I understand a bit better now and see that foreign vs. domestic shouldn't matter.

So here's another question. Apparently the Fed now owns about 60 percent of the U.S. debt. For that 60 percent, your proposal seems like a no-brainer. Why pay unnecessary middlemen?

But what about the remaining 40 percent? If the Fed were to buy that, wouldn't that represent a huge monetary expansion?

I don't know if it would be huge.  The Treasury would still owe the principle on the debt to the Fed, but the Fed would return the interest payments to the Treasury.  The people who hold the debt now would get their money sooner rather than later.  The immediate term Fed injection of cash could be offset somewhat by the later Treasury payments to the Fed.  Whether or not to monetize those payments would be a separate decision.

The point of my proposal isn't really to say that we always have as much free money as we need, since managing price stability is always an issue.  But I think the public would be much less confused about what is actually going on if we re-arranged the responsibilities and got the Treasury out of the debt-issuance game.  The Treasury would tax an spend, and fund deficits by creating money rather than borrowing.  The Fed would basically pay interest on dollar reserves and charge fees on dollar reserves to manage interest rates.   If Congress worries that we are expanding the monetary base too rapidly and creating inflation pressure, they can then decide what to do about that: tax more, spend less, or raise interest rates.  But the Peter Petersons and other like them would be able to scare people into contracting spending by telling them we're on the verge of bankruptcy or insolvency.

OK, thanks. It makes a lot more sense to me now. Eliminating the dealers seems obvious. What is the existing rationale for preventing the Fed from loaning directly to Treasury?

Does it really make sense to split monetary authority between Treasury (money creation) and the Fed (interest rates). Might they not end up working at cross-purposes?

PS While I agree that a change of metaphor would be helpful, I would not assume that you can just get rid of the Peter Petersons. Hyperinflation can be just as scary a bogeyman as debt, as the Germans have been demonstrating for the past couple years.

If Smith is Dimon in Dan's example, then the Fed uses him and its other Primary Dealers to manage the money supply, among other things.

From Wikipedia:

In the United States, a primary dealer is a bank or securities broker-dealer that is permitted to trade directly with the Federal Reserve System ("the Fed").[2] Such firms are required to make bids or offers when the Fed conducts open market operations, provide information to the Fed's open market trading desk, and to participate actively in U.S. Treasury securities auctions.[3] They consult with both the U.S. Treasury and the Fed about funding the budget deficit and implementing monetary policy. Many former employees of primary dealers work at the Treasury because of their expertise in the government debt markets, though the Fed avoids a similar revolving door policy.[4][5]

See FOMC operations where with the wave of a wand over a top hat, money is transformed into US Treasuries (and other things post TARP) to reduce the money supply and then back again when it is increased.  

http://www.newyorkfed.org/aboutthefed/fedpoint/fed48.html

http://en.wikipedia.org/wiki/Open_market_operations

Voila, money is debt; debt is money.  

Thanks. So why isn't debt considered part of the money supply? Total debt is much larger than MZM, right?

Good questions.   Defining what is and isn't money appears to be an arbitrary and ongoing process.  Remember the Fed just recently switched from M3 to MZM and I remember a conversation from several decades ago discussing whether or not credit card lines should be included.  

I worked with electronic digits my entire career but only began thinking about the nature of money after 2008.  I am enthralled enough to go back to school to formally study finance, hopefully this fall.  Maybe then I can answer your questions.

The Fed no longer attempts to target the money supply.  They tried that during the Volcker era during the high tide of monetarism and it was a complete failure.  The central bank can't really target the money supply, since the supply of money is mainly driven by endogenous factors in the market for credit.  The Fed has to accommodate commercial bank credit expansion to ensure the smooth functioning of the payments system.  All they can really control is the price of reserves - interest rates - not the quantity of reserves.

Yes I think it doesn't make a difference.  But as far as the mechanics go, my understanding is that Treasury securities are priced, quoted and auctioned in dollars, and so to buy them you have to use dollars.  If all you have is a foreign currency, you have to exchange that currency for dollars with some kind of forex trade.  I assume it doesn't make much difference since there are so many intermediaries who will do this.

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