All Your Bases and Dead Presidents Are Belong to the Government?

A serious wonk debate has broken out over the trillion dollar coin and its ramifications.  As I said 18 months ago when I first discussed the coin here, this idea was never going to come to fruition, but it made for a seriously important discussion regarding our monetary system.  All roads lead to MR on this debate, whether through MR co-founder Carlos Mucha, who founded the coin idea or the inevitable debate over government self financing and JKH’s Contingent Institutional Approach).

Paul Krugman asks the question that all of this debate inevitably leads to:

“what happens if the US government issues a trillion-dollar coin to pay its bills?”

I would change the question slightly for the sake of simplicity.  Instead of a coin, what if the government used its powers as an autonomous currency issuer to just create bank deposits?

It might help to step back a second first before we jump in the mud here.   The monetary system we currently have does not operate as most people believe.  The government doesn’t “print money” (except in the literal case of cash notes and coins), but is actually the issuer of net financial assets.  So, when Peter uses his Treasury Direct account to buy a government t-bill he is divested of a bank deposit that ultimately allows the government to spend a bank deposit into Paul’s account.  Peter gets a US T-bill, no longer has a bank deposit and Paul ends up with  a bank deposit.  There is the same amount of bank deposits in the private sector, but there is an additional financial asset in the form of the bond.

But what if the government didn’t sell t-bills?  Instead of divesting Peter of a bank deposit (and giving him a NFA as t-bill) the government would just type a bank deposit into Paul’s account when Congress wants to spend.  So Peter still has his bank deposit AND Paul has a net financial asset in the form of a bank deposit.  The government, in this case, is a pure issuer of money.  If one were so inclined to call t-bills pure “money” you could claim that the first and second example are virtually the same (aside from the obvious politics involved).

The question this argument really gets at the heart of is the moneyness of government bonds versus bank deposits.  I have argued that t-bills have a very high level of moneyness.  That is, they are highly liquid and risk free, but not pure money.  For instance, if two men are standing in Wal-Mart, one holding $100 in cash (or a credit card) and the other holding $100 in physical t-bills they do not both have money in the eyes of Wal-Mart (the problem of money is not defining it, but convincing others to accept it).  Ie, they cannot both ring the register.  One must sell his t-bills to the other to obtain the cash for purchases.  Now, technology is reducing the discrepancy in “moneyness” between these assets, but the inconvenience of transferability still exists to some degree.  A bank deposit will always have a higher level of “moneyness” than a t-bill.   How this discrepancy influences inflation is up for debate.

But an equally important debate rages over the monetary base and Krugman’s “dead presidents” (cash).   Ultimately, the question in the above discussion leads to a debate over inflation, the degree to which the Fed maintains control of the money supply and the very design of our monetary system.  But first we should agree on a few things:

  • Money is almost entirely endogenous in our monetary system.  Ie, the money supply is determined by private banks who issue loans based on the demand by their clientele.
  • The money multiplier is not just broken.  It is non-existent.  Bank loans create deposits.  Banks find reserves after the fact if they must.
  • The central bank can influence the cost of supplying these loans, but has far less control over the demand for this money.
  • The terms “base money” and “high powered money” are unfortunate terms that should be done away with as they put the cart before the horse in terms of understanding the first three bullet points here.

If the bullet points didn’t help connect the dots already, we should all be realizing that the Fed has less control over the money supply than most of us have been led to believe.  The money supply being endogenously controlled by the banking system means that the Fed can influence the cost of money, but cannot completely control the supply of money.  The money supply is largely regulated by market conditions and the demand for loans.  In other words, the money supply is almost entirely privatized in the USA.  The Fed tries to influence the cost of this money by gauging economic conditions and forecasting policy changes to economic agents.

So, what happens to this system if the government self finances?  Obviously, we’re entering a monumental paradigm shift. We’re transferring from a system where money is created endogenously by banks who compete to issue money, to a system where the government exogenously creates money.   It’s almost impossible difficult to say whether one system is more inflationary than the other.  But what becomes clear in a system of government self financing is that the existence of private banking becomes increasingly less significant which would render the need for the central bank as increasingly less significant (since the central bank exists to support private banks and operates policy through the banking system).

The trillion dollar coin is not a debate about Fed influence, inflation and dead presidents.  It is a debate about a monumental paradigm shift in our monetary system.  A debate that shakes the core of modern banking and the monetary system we have designed around a  market based money issuing system where banks compete privately to issue money as debt.

Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

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  1. BOJ -Bank of Japan
    BS -Balance Sheet
    ECB -European Central Bank
    ETF -Exchange-Traded Fund
    Fed/PD -Federal Reserve/Primary Dealers?
    GDP -Gross Domestic Product
    HPM -High Powered Money
    IMHO -In My Humble Opinion
    IR -Interest Rate
    JG -Job Guarantee
    MMT -Modern Monetary Theory
    MR -Monetary Realism
    NFA -Net Financial Assets
    QE -Quantitative Easing
    TDC -Trillion Dollar Coin
    TPTB -The Powers That Be
    TT&L -Treasury Tax & Loan Accounts
    USG -United States Government
    UST -United States Treasury
    USTs -United States Treasuries

  2. How odd… is anybody else seeing indentation failing at the bottom of this list of comments?

  3. Is anybody else having this trouble? I seems this article, “All Your Bases…,” has exceeded some limit on the size of the comments section, and has gone onto a 2nd page… but now all the links in the RECENT COMMENTS box at the right are screwed up… you can no longer click on one to take you to the comment if it happens to be on the 1st page of comments. Same is true for “Ask Cullen” if the comment you’re trying to get to is not on the most recent page of activity.

  4. BTW, did anybody catch Stephanie Kelton as a panelist on MSNBCs’ “Up” with Chris Hayes last Saturday? (it’s on their website). They were discussing the $1T coin. Stephanie is an MMTer… and she did an OK job, but she fumbled a bit when Chris asked, “So what’s to prevent us from minting a $10T or a $100T coin!” … instead of responding “Well, wait a minute Chris… I’m not proposing that there aren’t ANY constraints [then launch into an inflation discussion]” she unfortunately said “Nothing! That won’t change anything!” .. she went on to make a good point, but OF COURSE the discussion changed direction before she could get to the inflation constraint bit… it was left to another guest to eventually bring up the inflation constraint… making poor Stephanie look a bit like a whack job I think, to your average viewer… it certainly had the two skeptics on the panel rolling their eyes. Too bad!

    • Saw it, sort of enjoyed it, but those things are always too clipped to sway the masses. Interviewers always seem to ask the wrong question at the wrong time or break in with a contra-argument before the full point is made. MMTers seem to always end up sounding a little fantasmic. Too bad. But she is getting quite a bit of air time lately.

  5. There seems to be a flaw in all of this. If the government spent money directly into people’s accounts how would this not be more inflationary? For instance, let’s say there’s $200 in bank deposits the economy. Let’s say I own all of it. Let’s say I form a government for fun and decide to spend $100. First, we tax $50 and then deficit spend $50. So the government takes $50 in and sells $50 in bonds which allows it to spend $100 total. After all the spending and bond issue Fred has $100 in bank deposits and $100 in t-bills. Now Cullen has $100 from the government spending.

    But I can’t spend that $100 in t-bills. I can only spend $100 in bank deposits. I have to sell $100 in t-bills to Cullen if I want to spend that $100 also. So my spending is constrained by the AGGREGATE bank deposits of $200. In theory, we can sell our t-bills for spending, but no one really does that. After all, they’re our savings.

    So think about what would happen if the government spent bank deposits directly into our accounts. We would all be without sufficient savings. We’d all scramble to find other interest bearing assets. And the private sector would be forced to supply them. Or the government would supply them thereby sterilizing (defeating) whatever the purpose of self financing was. So, if the private sector supplied the new savings bonds we’d have the private sector offsetting the decline in t-bill issuance, but we’d also have more money. How does this not lead to inflation?

    • Lets try it and find out! If you provide the $200, I’ll form the “government” … whadya say? ;)

      Actually I’ve thought that if you could just get enough extremely nerdy online gamers, willing to participate in a simulation game of the economy … with some hierarchy of prizes to win … combined with an entry fee (in an attempt to just let the serious folks participate) then we might be able to test some of these ideas out.

      We could have several different ideas, and you’d be randomly assigned to a world: Austrian World, Free Banking World, Neo-Liberal World, MMT World, MM World, etc. Then evaluate a lot of measures of economic health at the end of the simulation. Maybe you’d have to carry the simulation forward for a few decades though…

    • Frederick, you don’t have to sell the T-Bill to Cullen at all, your the government “here’s my t-bill, please give me my $100″…by definition of a T-bill you’d have to ‘print the money’, since you were ‘deficit spending’ this implies you don’t have cash on hand so you’d have to “print”(execute an exchange for a bank deposit) it, but since you are the government you have infinite power to do that. Unfortunately I’m more than a little confused by the math in your example, for instance I don’t see how you got to $100 in T-Bills when you only sold $50 worth.

      But I can’t see how government ‘spending’ directly in to an account could possibly be ‘more inflationary’, it has to be less OR at the very least ‘equivalent’ but it’s hard for me to see the latter..

      Example: Size of Budgeted Deficit: $100 (say a birthday cake for the President’s secretary just to make it a ‘consumable’)

      First ‘Direct Spending’

      Government spending Direct (via ‘printing’ of money) in to Bakers account: $100
      Amount ‘spent’ in to the economy: $100

      Now by ‘issuing of T-Bills’

      Value of T-Bill that matures ‘tomorrow’: $110 (Could be $108 or $104, I don’t know the ‘going rate of return’)
      Currency Acquired: $100
      Amount ‘spent’ in to the economy: $100
      Amount ‘removed’ from the economy; $100 (from whomever bought the T-Bill)
      Amount ‘financed’ for T-Bill: $10 (someone’s savings)

      The $100 ‘budgeted to be spent’ is EXACTLY same in both cases. But in the T-Bill case the government owes $110 ‘tomorrow’ to the purchaser of the T-Bill. $100 to ‘replace’ the deposit used to buy the T-Bill plus the $10 ‘extra’ that was promised. So if ‘tomorrow’ they want to buy another birthday cake, say for the White House janitor the government has to ‘deficit budget’ not just $100 but $110 because they now ‘owe’ $10 from financing of the T-Bill ‘today’. When ‘tomorrow’ comes they issue a T-Bill not for $110 but $210 dollars, from the proceeds they deposit $110 in to the original T-Bill purchasers account because they owe it to him, he now has $10 extra compared to ‘yesterday’ & they have $100 for buying another birthday cake. But now the government owes $210 NOT $110! Rinse & Repeat.

      So, there is 0 way that I can see that ‘direct deposit’(self financing/printing of money) by the Fed can be MORE inflationary, at worst it is ‘equivalent’ but that’s only as long as the ‘savers’ do not cash in the T-Bills & spend the proceeds, in the example above if the original T-Bill purchaser takes his $10 & goes & buys a meal rather than reinvest it then the exchange has resulted in increased inflation in the economy beyond that with ‘self financing’.

      Yes the T-Bill is ‘savings’ but the government can and does promote savings in many other ways (e.g. tax breaks for deposits in to a 401k, part of which may in fact be a Treasury Security if they are available). If the goal is to promote ‘savings’ there’s many ways to do that and as you’ve indicated the private sector would certainly step up & provide them, in fact isn’t that the ‘US Capitalist mentality’? They would be of higher risk than a T-Bill of course, but coming from the Private Sector I presume the securities are being issued to get funds for investment in capital or something like that…but now I’m well passed the original point of the example.

  6. It finally occurred to me what was really wrong with Cullen’s article & all the ‘doom & gloom’ scenarios about nationalizing the banks etc. The premise used to produce those scenarios is NOT just ‘government self financing’, they all consistently ignored the government’s primary ‘fiscal’ responsibility to ‘control inflation’…so in all the negative arguments against ‘self financing’ the ‘paradigm shift’ was not only self financing but that the government would further ‘ignore it’s responsibility to control inflation’ that in fact would be one hell of a paradigm shift.

    But as Cullen’s primary treatise on MR makes clear the government’s primary responsibility IS inflation (not Debt = Private Savings). So sure, if you also add this to the arguments then ‘doom & gloom’ is the result, but if you add it to ‘self financing’ you have to add it to the current situation and therefore the T-Bill ‘financing’ will lead to hyperinflation & all kinds of ‘bad things’ too.

    I have read no negative scenario with regard to ‘self financing’ that does not ultimately end with the government ignoring it’s inflation responsibilities.

    Now, what I’d like to know is why the government would ever promise to pay someone $1.04 tomorrow for the dollar it can make itself today? From a purely business perspective that’s not just dumb that’s fiscally criminal. Yes the government isn’t a ‘household’ and isn’t a ‘business’ but that doesn’t mean that government should be inefficient profligate spenders. Sure, it can ‘promote savings’ but there are many other ways for the government to do that (tax incentives), and besides that if I understand correctly the majority of those ‘savings’ are going to China & the Banks…I haven’t read enough to entirely understand why China needs US dollars as savings (so I’ll cut them slack until I do) but since Banks don’t lend their savings increased Bank savings does nothing for increasing Bank loans. Why shouldn’t banks have to save money out of their profits like everyone else? What makes them so special that the government should just GIVE banks ‘savings’ for nothing? Especially when they have also given them the power to create money from nothing by virtue of issuing loans.

    Furthermore, maybe there is a benefit to promoting savings but that doesn’t always have to be the case. The government could do either at different times or do both at the same time, it’s not an ‘exclusive either or’ forever decision. It would seem to me that right now would be a perfect time to ‘self finance’, I don’t see any reason to ‘promote savings’ right now, in fact isn’t part of the problem that companies & individuals are not spending their ‘savings’ thus the desire for the government to spend more then it otherwise might have to?

    If there is an article on this site or elsewhere that explains the benefit for the government promoting bank savings in the context of MR I’d love to know about it…

    • Sure, if you assume that self financing won’t result in other institutional changes then there’s no big difference. But then what’s the point? If we all know the govt can’t run out of money as is then why change anything?

      I don’t think you realize what self financing would mean. It would mean that the institutional structures would change completely. The Fed’s role in the economy would be substantially reduced. There would be no need for banking involved in the govt clearing process. No Primary Dealer system. And on and on. We’re not talking about some small minor change. We’re talking about sweeping changes to the way the banking system works and the way the institutions are designed and operate. MMT’s ideas are even more extreme. They’d consolidate the Fed into Tsy and would love to see the role of pvt banking reduced substantially. Many of them want nationalized banking. That all sounds fine in theory, but it’s far more complex and sweeping than most make it sound.

      You all make this sound like it’s some minor change. Anyone who says that doesn’t understand the design of our system.

      • Thanks for the reply, and again, thanks very much for the ‘education’ it’s been most valuable.

        Why change anything? Well how about to stop paying for ‘money laundering’ of government money? Money the government could use directly in the economy instead of being filtered through the financial markets to ‘who knows what end?’

        I’m not an ‘MMTer’ (I don’t even ‘know’ what that is other then what the initials stand for and your railing against their ‘theories’. :-).), I’m a ‘macroeconomic illiterate’ trying to learn. And yes admittedly I do not know exactly the Fed role in the economy due to it’s involvement in government money laundering. But you’ve explained extremely well that there are 2 types of money & that it’s the ‘inside money’ that ‘rules the roost’, so unless your saying that the institutional changes involved in ‘government self financing’ (all other things being equal, e.g. no ‘government spending like a drunk pirate’ etc.) are such that the private banking system will be fundamentally, irretrievably altered then the Fed still has a substantial role to play in the economy managing the effects of banks making poor credit worthiness decisions.

        I’m not suggesting it wouldn’t be a significant change, and I’ll go back & read your original treates on ‘how the monetary system works’, but frankly, from my point of view, the bigger ‘paradigm shift’ is in what you are doing to educate people about how the monetary system works, when it’s recognized that ‘debt = Private Savings’, the government can’t go broke & the primary duty of the government in managing the economy (other than social reasons..) is to control inflation…that itself changes the discussions drastically in my opinion, as more people understand MR, the less time wasted fighting over ‘debt ceilings’ and the less people will fall for scare tactics over ‘debt’.

        • You’re welcome.

          My point is that I think there are a lot of people who run around on blogs and the internet just throwing out baseless rants about the banking system without really knowing much about it. I’m not a bank apologist and I’ve been plenty critical of the banks, but I think we have to be careful about calling to tear down the whole thing and reduce it to nothing. Banks and shadow banking didn’t just evolve into the entities they are today for no reason. We have a really really complex financial system that requires some pretty sophisticated designs. The rise of shadow banking is largely the result of the rise of the GSEs, commercial paper funding, REITs and mutual fund growth, money market mutual fund growth, broker dealer growth, securitization and a really complex and enormous economy. Traditional bank lending is becoming a more modest portion of our economy because it doesn’t serve the needs of all these complex entities. Further, regulations have been woefully behind in catching up to all these changes. So it’s not surprising that the banking system is still pretty fragile.

          If we’re going to move to govt self financing then we have to be mindful of the ways that will likely ripple through this complex web of structures already alive in the financial sector. You can’t just tear them down like some people think. They serve a real purpose for the most part and are instrumental pieces of the economy. Once we start picking the Federal Reserve apart and removing the need for Primary Dealers and other pieces of this puzzle we’re heading down a road that is, BY DEFINITION, more state controlled. Do you want the govt trying to manage all of these complex financial transactions through some silly bureaucracy? If not, we need to better understand what we have, regulate it properly and not go all overboard saying we should permanently self finance and head down a road that is, by definition, a marginalization of the private banking system.

          • O I know all about people running round ‘the internet spouting baseless claims’…I’ve been ‘on’ the internet long before anyone knew what it was, I’ve seen more than my fair share…

            I assure you I have no intention to ‘bring down the banks’, I recognize there is a need for them in a capitalist society. A government that can ‘print’ it’s own money has no incentive to make proper ‘credit worthiness’ decisions so we don’t want them being ‘the bank’…and no I don’t want more bureaucracy that’s totally inefficient so regulation it is. But even with regulation there can be issues if the regulators have no incentive to not ‘game the system’ (e.g. make it less efficient & less transparent).

            Having said that, I simply didn’t(and still don’t) see the leap made in your article from ‘government self financing’ for it’s spending to the money supply becoming totally exogenous. It replaces how ‘outside money’ is created it doesn’t (absent any other information) affect the supply of ‘inside money’. So I’ll accept that it’s a ‘huge change’ & perhaps a ‘paradigm shift’ while reserving judgment that it includes replacement of banks as the creators of ‘inside money’…again, I’ll keep reading, perhaps it will become obvious.

            Ultimately for someone who had spent very little time reading about this previously I felt I was able to ‘keep up’ pretty well in understanding every other article you’ve written, in this case though I simply couldn’t & can’t make the leap suggested in the conclusion of your article.

            Again, thanks very much & keep up the great work. MR is ‘about the facts’, facts can’t be argued with.

  7. Cullen, reading the comments, I’d say, you have a job cut out for you. Forgetting about MMT and all the history associated with it, and imagining a total outsider coming and suggesting consolidated Fed/Tsy entity (or govt self-financing not with issuance of bonds but with direct deposits of funds into the payee accounts) try to convince us why this is very likely result in the end of private banking. Again, MMT or its founders opinions are irrelevant here. Here’s the proposed institutional change, what are the likely consequences?
    Meanwhile, Krugman and Waldman are having a really important debate about whether self-financing with reserves that pay IOR vs financing with bond sales bonds are the same thing even outside of today’s conditions (that PK likes to call liquidity trap.) I used to think like PK that IOR is just the same as bonds and I now realize I was most probably wrong. The difference is not only in the fact that reserves – unlike bonds – are convertible to cash on demand at par (the plastic apples and the real apples in Waldman’s example) but, more importantly, the fact that reserves never leave the banking system and the banks are not in the business of spending. Basically, the banking sector will absorb any increase in reserves (with or without additional IOR) and it will not lead to increased spending because as we know money multiplier is a myth and demand for loans is endogenous. This by the way in line with explanations here and here of the broken mechanism of QE.

    • I have my job cut out for me? I think you’re confusing our positions. MMT is the one arguing for a huge job guarantee, permanent budget deficits, the end of the Fed and other policies that are so far to the extreme end of the spectrum that there’s almost no chance we’ll see any of them enacted in our lifetimes. All I spend most of my time doing is telling people how the world currently operates.

      You seem to think that govt self financing and the current system are the same thing. As if MMT already exists. But we both know that’s not really true. A world of govt self financing would look very different than the one we currently live in. And realizing that there’s no solvency constraint really isn’t as eye opening as you and the MMT world seem to think. What do you think will happen when conservatives learn MR and understand that the govt harnesses the banks to fund spending? They’ll start worrying about inflation! Nothing will change. Literally, nothing. Their argument will change slightly, but nothing else really will.

      MMT needs bigger changes. You know it. I know it. So, I am afraid you’re the one who has his work cut out for him. Luckily, you guys are persistent and appear to have an army of people stationed on certain websites screaming out the message….Which, might be counterproductive, but whatever.

  8. Re: Govt. self-funding deficits leading to the end of private banking ….
    If the government got out of the business of issueing bonds, wouldn’t that *increase* demand for privately issued bonds. Wouldn’t there be a huge pool of investors who currently buy treasuries who would now be willing to lend to corporations or other entities?

  9. The funny thing is that everyone seems to look at this utopian idea as the solution to all problems. The alarming fact is that the same people, who seek to live in cuckooland do not realize that the situation is more serious than it looks. When somebody starts issuing imaginary money, you would end up granting an ‘imaginary’ status to the dollar. Do you think the Chinese, Indians, Brazil, EU, etc all would be interested in trading in US$? They produce, export and would not want to be paid by ‘imaginary’ money minted at will.
    That is not how capitalism is supposed to operate. Maybe that is the root cause of all this mess?

    • I don’t think that Chinese, Brazilian, Indian, Korean, Japanese, Swiss, Russian, Canadian, British, Euros, etc. etc. etc. currencies are any less imaginary than our dollars. They all have a similar floating exchange rate fiat money system, which is similar to ours. In fact the Chinese are always trying to devalue their money in relation to ours. … well, OK, perhaps that’s an oversimplification, but generally the idea. Look at Japan… they have been deficit spending for decades, and have a much greater public debt to GDP ratio than we do… and yet they’ve been on the verge of DEFLATION (having their “imaginary money” GAIN value!) now for a long time in spite of it. Just recently (with Abe again as PM) I think their strategy is transitioning to targeting a higher inflation rate (a devaluation of their currency).

      I’m not sure your concerns about “imaginary” money is really valid. That’s the way it is the world over! If China were to truly let their currency float, their trade surplus would push their currency up in value, and make their exports less attractive (at least that’s the way I understand how Milton Friedman envisioned this floating exchange rate system to work). That fact that that doesn’t happen is what has people up in arms about China being a “currency manipulator.” Of course there’s another way to look at that situation … that sees China and Brazil, etc. as NOT really wanting to buy any more dollars, and thus looking to trade amongst themselves w/o $.