dagblog - Comments for "Why Does Uncle Sam Borrow?"

OK, thanks. It makes a lot

Michael Wolraich — Mon, 30 Apr 2012 15:43:04 +0000

In reply to I don't know if it would be

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.

The Fed no longer attempts to

Dan Kervick — Mon, 30 Apr 2012 02:12:41 +0000

In reply to Thanks. So why isn't debt

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.

I don't know if it would be

Dan Kervick — Mon, 30 Apr 2012 02:08:30 +0000

In reply to Thanks, Dan. I understand a

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.

Good questions. Defining

EmmaZahn — Mon, 30 Apr 2012 00:53:09 +0000

In reply to Thanks. So why isn't debt

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.

Thanks. So why isn't debt

Michael Wolraich — Sun, 29 Apr 2012 22:38:22 +0000

In reply to If Smith is Dimon in Dan's

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

Thanks, Dan. I understand a

Michael Wolraich — Sun, 29 Apr 2012 22:32:57 +0000

In reply to It buys the T-bill from Smith

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?

It doesn't. Wen Bo parks his

EmmaZahn — Sat, 28 Apr 2012 18:47:44 +0000

In reply to So what about Wen Bo? He's

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.

If Smith is Dimon in Dan's

EmmaZahn — Sat, 28 Apr 2012 18:40:33 +0000

In reply to Maybe I'm misunderstanding

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.

Same thing. Wen Bo's

Dan Kervick — Sat, 28 Apr 2012 16:00:45 +0000

In reply to So what about Wen Bo? He's

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 buys the T-bill from Smith

Dan Kervick — Sat, 28 Apr 2012 15:26:28 +0000

In reply to Maybe I'm misunderstanding

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.