The Biggest Myths in Economics

Heidi Moore asked a good question on Twitter yesterday about the most prominent myths in economics. I’ve compiled a substantial number of “myth busting” articles over the last 5 years so I thought it might be worth touching on a handful of the more destructive ones in some detail. A lot of this will be very familiar to regulars, but should provide a nice summary regardless.  So here we go:

1) The government “prints money”.  

The government really doesn’t “print money” in any meaningful sense.  Most of the money in our monetary system exists because banks created it through the loan creation process.  The only money the government really creates is due to the process of notes and coin creation.  These forms of money, however, exist to facilitate the use of bank accounts.  That is, they’re not issued directly to consumers, but rather are distributed through the banking system as bank customers need these forms of money.  If the government “prints” anything you could say they print Treasury Bonds, which are securities, not money.  The entire concept of the government “printing money” is generally a misportrayal  by the mainstream media.

See the following pieces for more detail:

2)  Banks “lend reserves”.  

This myth derives from the concept of the money multiplier, which we all learn in any basic econ course.  It implies that banks who have $100 in reserves will then “multiply” this money 10X or whatever.  This was a big cause of the many hyperinflation predictions back in 2009 after QE started and reserve balances at banks exploded due to the Fed’s balance sheet expansion.  But banks don’t make lending decisions based on the quantity of reserves they hold.  Banks lend to creditworthy customers who have demand for loans.  If there’s no demand for loans it really doesn’t matter whether the bank wants to make loans.  Not that it could “lend out” its reserve anyhow.  Reserves are held in the interbank system.  The only place reserves go is to other banks.  In other words, reserves don’t leave the banking system so the entire concept of the money multiplier and banks “lending reserves” is misleading.

See the following for more detail on the basics of banking:

Also see this Fed paper on this topic:

3)  The US government is running out of money and must pay back the national debt.

There seems to be this strange belief that a nation with a printing press whose debt is denominated in the currency it can print, can become insolvent.  There are many people who complain about the government “printing money” while also worrying about government solvency.  It’s a very strange contradiction.  Of course, the US government could theoretically print up as much money as it wanted.  As I described in myth number 1, that’s not technically how the system is presently designed (because banks create most of the money), but that doesn’t mean the government is at risk of “running out of money”.   As I’ve described before, the US government is a contingent currency issuer and could always create the money needed to fund its own operations.  Now, that doesn’t mean that this won’t contribute to high inflation or currency debasement, but solvency (not having access to money) is not the same thing as inflation (issuing too much money).

See the following piece for more detail:

4)  The national debt is a burden that will ruin our children’s futures.  

The national debt is often portrayed as something that must be “paid back”.  As if we are all born with a bill attached to our feet that we have to pay back to the government over the course of our lives.  Of course, that’s not true at all.  In fact, the national debt has been expanding since the dawn of the USA and has grown as the needs of US citizens have expanded over time.  There’s really no such thing as “paying back” the national debt unless you think the government should be entirely eliminated (which I think most of us would agree is a pretty unrealistic view of the world).

This doesn’t mean the national debt is all good.  The US government could very well spend money inefficiently or misallocate resources in a way that could lead to high inflation and result in lower living standards.  But the government doesn’t necessarily reduce our children’s living standards by issuing debt.  In fact, the national debt is also a big chunk of the private sector’s savings so these assets are, in a big way, a private sector benefit.  The government’s spending policies could reduce future living standards, but we have to be careful about how broadly we paint with this brush.  All government spending isn’t necessarily bad just like all private sector spending isn’t necessarily good.  And at a macro level debt doesn’t get “paid back”.  In a credit based monetary system debt is likely to expand and contract, but generally expand as the economy expands and balance sheets grow.

See the following pieces for more:

5)  QE is inflationary “money printing” and/or “debt monetization”.  

Quantitative Easing (QE) is a form of monetary policy that involves the Fed expanding its balance sheet in order to alter the composition of the private sector’s balance sheet.  This means the Fed is creating new money and buying private sector assets like MBS or T-bonds.  When the Fed buys these assets it is technically “printing” new money, but it is also effectively “unprinting” the T-bond or MBS from the private sector.  When people call QE “money printing” they imply that there is magically more money in the private sector which will chase more goods which will lead to higher inflation.  But since QE doesn’t change the private sector’s net worth (because it’s a simple swap) the operation is actually a lot more like changing a savings account into a checking account.  This isn’t “money printing” in the sense that some imply.

See the following pieces for more detail:

6)  Hyperinflation is caused by “money printing”.  

Hyperinflation has been a big concern in recent years following QE and the sizable budget deficits in the USA.  Many have tended to compare the USA to countries like Weimar or Zimbabwe to express their concerns.  But if one actually studies historical hyperinflations you find that the causes of hyperinflations tend to be very specific events.  Generally:

  • Collapse in production.
  • Rampant government corruption.
  • Loss of a war.
  • Regime change or regime collapse.
  • Ceding of monetary sovereignty generally via a pegged currency or foreign denominated debt.

The hyperinflation in the USA never came because none of these things actually happened.  Comparing the USA to Zimbabwe or Weimar was always an apples to oranges comparison.

See the following pieces for more detail:

7)  Government spending drives up interest rates and bond vigilantes control interest rates.  

Many economists believe that government spending “crowds out” private investment by forcing the private sector to compete for bonds in the mythical “loanable funds market”.   The last 5 years blew huge holes in this concept.  As the US government’s spending and deficits rose interest rates continue to drop like a rock.  Clearly, government spending doesn’t necessarily drive up interest rates.  And in fact, the Fed could theoretically control the entire yield curve of US government debt if it merely targeted a rate.  All it would have to do is declare a rate and challenge any bond trader to compete at higher rates with the Fed’s bottomless barrel of reserves.  Obviously, the Fed would win in setting the price because it is the reserve monopolist.  So, the government could actually spend gazillions of dollars and set its rates at 0% permanently (which might cause high inflation, but you get the message).

See the following pieces for more detail:

8)  The Fed was created by a secret cabal of bankers to wreck the US economy.

The Fed is a very confusing and sophisticated entity.  The Fed catches a lot of flak because it doesn’t always execute monetary policy effectively.  But monetary policy is not the reason why the Fed was created.  The Fed was created to help stabilize the US payments system and provide a clearinghouse where banks could meet to help settle interbank payments.  This is the Fed’s primary purpose and it was modeled after the NY Clearinghouse.  Unfortunately, the NY Clearinghouse didn’t have the reach or stability to help support the entire US banking system and after the panic of 1907 the Fed was created to expand a system of payment clearing to the national banking system and help provide liquidity and support on a daily basis.  So yes, the Fed exists to support banks.  And yes, the Fed often makes mistakes executing policies.  But its design and structure is actually quite logical and its creation is not nearly as conspiratorial or malicious as many make it out to be.

See the following pieces for more detail:

9)  Fallacy of composition.  

The biggest mistake in modern macroeconomics is probably the fallacy of composition.  This is taking a concept that applies to an individual and applying it to everyone.  For instance, if you save more then someone else had to dissave more.   We aren’t all better off if we all save more.  In order for us to save more, in the aggregate, we must spend (or invest) more.  As a whole, we tend not to think in a macro sense.  We tend to think in a very narrow micro sense and often make mistakes by extrapolating personal experiences out to the aggregate economy.  This is often a fallacious way to view the macroeconomy and leads to many misunderstandings.  We need to think in a more macro way to understand the financial system.

10)  Economics is a science.  

Economics is often thought of as a science when the reality is that most of economics is just politics masquerading as operational facts.  Keynesians will tell you that the government needs to spend more to generate better outcomes.  Monetarists will tell you the Fed needs to execute a more independent and laissez-fairre policy approach through its various policies.  Austrians will tell you that the government is bad and needs to be eliminated or reduced.   All of these “schools” derive many of their understandings by constructing a political perspective and then adhering a world view around these biased perspectives.  This leads to a huge amount of misconception which has led to the reason why I am even writing a post like this in the first place.  Economics is indeed the dismal science.  Dismal mainly because it’s dominated by policy analysts who are pitching political views as operational realities.

See the following piece for more detail:

There’s a lot more where that came from.  You can read more myths here.  I would also highly recommend my paper on the monetary system.

* A video version of some of these myths can be seen here.

Cullen Roche

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. He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance and Understanding the Modern Monetary System.

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  • SS

    This is one of the best posts you’ve ever written. Bravo.

  • Suvy

    Cullen, the only place I would disagree is on the issue of the national debt. All debt involves a transfer of real resources. If the transfers aren’t productive, then you effectively reduce real demand and the debt burden will drag on growth. Eventually, the debts will either have to be cleared or the increased debt burden will continue to eat away from growth.

    Debt servicing costs must be paid. Bankruptcy forces the costs on the lender and there’s a short term demand blip from bankruptcy. Although in the long run, writing down debts is probably the best way to deal with an excessive debt problem and is much superior to transferring the debt onto the government’s balance sheet.

  • Cullen Roche


  • Cullen Roche

    Yes, if the govt spends inefficiently then there could be negative consequences. I totally agree. But debt isn’t always bad whether it’s public or private. But it sure can be….

  • Nils

    Minor point: Weimar is a city, not a country. Surely you wanted to write “Weimar Republic”.

  • Nils

    Good thing that public servants are always about efficiency then.

  • InvestorX

    Here my quibbles:

    1) Well QE has led to the issuance of $2-3tr of M2 deposits (fully backed by reserves) as most of the dealings were with the public as the ned recepient. Although the banks issued the deposits, it was a direct and unavoidable consequence of QE.In that sense govt (Fed) printed digital money.

    4) Well interest must be paid, which is a burden (to the middle class and poor). This interest is partially paid via tax collection. Maybe it is just wealth redistribution from bottom to top, but it is not as innocent as you want ot make us believe.

    5) See 1). Also I thought you stopped seeing Treasuries as money / savings accounts (a MMT fallacy), but as assets.

    5+6) What would happen if the Fed prints $10-15tr p.a. and “swaps” with the public for assets? I doubt it would not be inflationary in any major way.

  • John-retailinvestor

    I agree with the peanut gallery. This was an awesome post. Bravo

  • LRM

    Great post !
    Puts a lot of the MR concepts to actual application and all in one place:)

  • But What Do I Know?

    Great stuff, Cullen. This only nit I will pick is that QE is not monetization. You are correct in the strict sense of the term, but the overall effect of the central bank buying up a significant and growing portion of the Treasury’s paper is to remove any financial system checks on government spending. The problem is not monetization per se, but the result when people figure out that the federal government spending is not deficit-constrained.

    Some of the other points really need to be shouted from the rooftops, especially, 2,3,7,9, and 10. . .

  • indignado

    Great summary of the MR view in one post. Cullen, I have a question on point 5 above..

    “When the Fed buys these assets it is technically “printing” new money, but it is also effectively “unprinting” the T-bond or MBS from the private sector.”

    So the fed exchanges newly “printed” reserves with private banks for their Tbonds and MBS and this creates no new assets in the inside banking system. However, the tbonds and MBSs are very much still “printed” but are now just on the Feds BS and off of the banks, right? And if this is the case and the fed today has roughly 50 billion in capital and 4 trillion in assets then they are an enormous quasi private, extremely leveraged financial institution, right?

    And if this is the case then the stability of the entrie system is predicated on your belief that the fed will always control a broad spectrum of interest rates through hell and high water. Am I fair in my assesment here? Thanks

  • Benjamin Cole

    I agree with others in that I would not just blithely dismiss federal debt. If the national debt gets too high, the taxes levied to cover it could be detrimental, especially if we have an income tax system. I suppose we could switch to a consumption tax system, and then the national debt would not matter so much.

    That said, I see nothing wrong with monetizing the debt at this juncture. That is what QE has been doing, and with little inflationary effect.

    Sure, i get it, some people sell bonds and stuff the money into the bank. Fine–the federal government (and taxpayers) do not owe them money anymore. They have their money.

    I say keep monetizing debt until we see inflation north of 5 percent.

    And that is the biggest economic myth of all: That moderate rates of inflation are some horrible sin.

  • Mike

    Confused on the first point a bit. In particular the statement, “not in any real sense”. If the federal government runs a trillion dollar deficit, isn’t congress approving the creation of a trillion dollars in base money that will flow through the economy. That is significant, isn’t it?

  • Anonymous

    Thats a great post Cullen, should be in Econ 101 for every student in the country. I differ with you on your definition of money, you only consider bank deposits money, which is too narrow IMO but its just a semantic difference.

  • Rick

    No 10 is the most important one, Econ is not a science but some mix of politics and ideology. This is nothggn wrong as long as we understand it. Here is a bit terse but good piece:

  • Suvy

    This made me laugh.

  • Odie

    Great points as usual, Cullen.

    However, I think the biggest myth of all is still that we can have economic growth forever. Since economic growth requires increased production of real goods and services that assumption is bound to fail on a planet with finite resources. We got a first glimpse in the last ~15 years as rapidly rising demand for commodities could not be adequately fulfilled and at least contributed to the 2008 crisis. We are pushing against the production boundaries of our planet and all monetary manipulations will be unable to change that.

  • Notagain

    Agreed but as capitalists we cannot think that way !

    best point made by Cullen is the last one …the rest we should all know these by now .

  • Andrea Malagoli

    Ok, we can all agree that QE is NOT inflationary. What is inflationary, though, is the unproductive spending using borrowing that’s encouraged by cheap rates. For example, if you use borrowed money to pay unemployment benefits to people who sit around doing nothing, that would create inflation, i.e. excess demand for goods not backed by adequate production of supply. Another clear effect can be seen in the preponderance of share buybacks to inflate equity prices, again helped in part by low rates of returns on cash and cheap debt.

    So, QE is not inflationary only directly. Hower, its indirect effects may well be. QE’s biggest risk is moral hazard.

  • Suvy

    The most important aspect of QE is the currency war aspect. We cannot ignore that! I don’t know why almost everyone chooses to do so. They always reference the share buybacks and all the other stuff without mentioning the currency war. It’s rather baffling to me.

  • jayedcoins

    I second that! I’m sure most of us, myself included, have read all these things in Cullen’s posts in the past, but this compilation of all these point was succinct. Could function as a perfect primer for folks that are new to the MR ideas.

  • jayedcoins

    If QE never existed, wouldn’t federal spending still be unconstrained by deficits? I don’t think QE matters here in a technical sense. I could maybe buy the argument about public perception. People do crazy things when they think they know or understand something to be “scary,” and once they have the idea that it is “scary” in their heads, it is almost impossible to convince them otherwise, even if you have the truth on your side.

  • jayedcoins

    I believe part of the point here is that the Fed, despite legally being quasi-public and quasi-private, doesn’t contribute to the net private sector balance sheet. After all, the Fed isn’t going to sell an asset and use the money to buy pizzas for everyone on the block. That’s really the point about monetary base expansion and inflation in this context.

    But I personally feel your point is also valid. I’m not a big fan of QE anyhow, but what you’re saying seems logical to me as another reason that the fact the “taper” was finally well-received by the markets was a great thing. Hopefully that continues.

  • pantmaker

    I think the notion that interest rates are singularly controlled by the fed and insulated from outside influences due to Fed liquidity doesn’t tell the full story. It actually made me chuckle because it reminded me how incredibly rediculous things have become lately and what our sense of “normal” has become. Anything that can be freely traded is eventually vulnerable to market forces including our nations credibility.

  • indignado

    I couldn`t agree more with you on the moral hazard created via QE and other CB unorthodox policies. Case in point, today here in Spain the 10 year bond has just eeked below 3,7%. It`s lowest mark since 2009.

    Today in Spain we have historic high rates on NPLs, real-estate market down 40% and still dropping, 27% unemployment, and endless list of government embezzlement scandals both regional and national and a completely off the whack tax regime. And the market prices the risk to loan to the Spanish government at a four year low of 3,7%.

    I see the same risks in HYBS markets in the U.S.. Savers are chasing yield with a false sense of security created by these CB policies. Our collective memories are short, but the amount of debt outstanding far outweighs the CBs ability to iron out a rebout of deflation.

    I believe the risk is insolvency, not inflation. Bankruptcies will push up rates, not inflation.

  • Geeoff

    I agree with both of these points, although with caveats.

    A large debt is a big deal and cannot be glossed over. However, a small debt is not a big deal and could actually enhance growth quite nicely.

    And secondly, monetizing debt is not a bad thing. Even if it creates a bit more inflation. However, I would start to get nervous with inflation at 5%.

  • Cullen Roche

    I plead ignorance on that one actually. Thanks.

  • Cullen Roche

    Hi InvestorX,

    The money issued by banks during QE is still liabilities of the pvt sector, NOT the public sector. So I don’t think it’s fair to say the govt issued the money unless you embed the banks into the govt (which I think we’d all agree is a no no).

  • Cullen Roche

    Thanks. I personally don’t like to combine fiscal policy and monetary policy via QE because I think they can be proven to be entirely independent, but I see how people prefer to view it that way. The counterfactual is a govt budget surplus with QE. Obviously, that wouldn’t be financing the govt.

  • Cullen Roche

    Right, but think of it this way. The Fed has a huge balance sheet that is, for all practical purpose, a void. The Fed doesn’t use its balance sheet in any meaningful way on a daily basis like the rest of us do. It doesn’t shop at Wal-Mart or use those T-bonds as leverage to buy stuff in the real economy. The Fed is just using its balance sheet to change the composition of the pvt sector’s balance sheet. Technically, with its bottomless barrel of reserves, you could say the Fed has a gazillion dollar balance sheet, but how relevant is that to real output? Not very.

    Make sense?

  • Cullen Roche

    Don’t get me wrong. I am not saying there are no potential problems with the national debt. I am simply pointing out that the US govt isn’t going to run out of its ability to finance the debt. Remember, running out of money and creating too much money are totally different things. Inflation is not just another type of insolvency. It is a totally different animal and govt policy that is poorly implemented could definitely cause high inflation.

  • Cullen Roche

    When the govt deficit spends it is really just approving the issuance of financial assets to finance the spending (the T-bonds). The govt doesn’t “print money” via deficit spending. It prints a bond. That is significant. In both positive and negative ways depending on the environment and its impact.

  • Cullen Roche

    Have you seen the scale of moneyness in my primer? I am fine saying that other things are money, but I just like to point out that bank deposits are the thing that has the highest level of moneyness in our monetary system.

  • Cullen Roche

    Yes. Interesting point. Better yet, do we NEED growth to survive? You could get very philosophical here….I don’t know the answer of course!

  • Cullen Roche

    I agree Andrea.

  • Cullen Roche

    I describe it like this. The Fed controls rates on US govt bonds, but the Fed does not control the economy. So, the Fed could keep rates at 0% forever. But it can’t keep inflation at 2% forever. So the Fed could be forced off its marker by the market. Or, it could keep rates at 0% and potentially exacerbate inflation.

    That’s how I think of it. Hopefully that makes sense.

  • Johnny Evers

    QE with a budget surplus is the same as QE with a budget deficit — it finances some *past* spending.
    Look at it this way — if government borrowed money from me 10 years ago to finance spending, and then today gives me my deposit back through QE it has effectively monetized the original spending. I get my deposit back and the the deposit created by deficit spending is still out there.

  • Cullen Roche

    Deficit spending doesn’t create deposits. It creates financial assets in the form of T-bonds. Deficit spending redistributes existing bank deposits.

  • Johnny Evers

    Right, I put that incorrectly. Deficit spending creates the NFA, but QE turns the NFA into a deposit.
    It’s like if I borrow a dollar from you and give you a marker, and then print a dollar and take the marker back.
    It’s monetization in two steps and it’s Ben Bernanke’s legacy. If it works, then it can do a lot of public good. If it fails, then the value of many financial assets will fall.

  • Cullen Roche

    They’re two different operations. You’re combining them, which is sloppy. Monetary policy and fiscal policy are not the same thing. They are distinctly different operations. You would never say that the Fed monetized MBS using your logic because MBS has nothing to do with deficit spending, but that’s essentially what you’re doing here. That makes absolutely no sense at all. Yet you constantly cherry pick the t-bond portion of QE and claim that this proves your view. It’s obviously a contradiction when you include MBS in the analysis.

    I don’t know why you insist on maintaining this view when it’s so easily disproven.

  • Chris Fischer

    So are you arguing that the most of the deficit spending is efficient (you know, towards infrastructure and things like that?)

  • Johnny Evers

    Yes, they are distinct operations. You can label one monetary and the other fiscal, but you must look at the parts as a whole.
    It is not cherry picking, It is looking at the complete operation.
    If you are discussing any loan, including deficit spending, it is silly to discuss only the loan part and not the part at the end.
    If you lend money to me, that is not the entire operation. You have to consider the loan must be paid back, rolled over, monetized, defaulted, etc.
    You only want to consider one part, because your theory is that deficit spending creates an NFA and that is the end of it. Once you consider the full operation, then many of your theories come into question, which is why you fight this so hard.
    The only alternative is that deficit spending is *not* lending, but just an operation that creates a NFA which would also be monetization. But you don’t want to accept that, either.

  • Cullen Roche

    Depends on your definition of “efficient”. Is it “efficient” to pay interest to military retirees whose pensions are in US govt accounts? Is it “efficient” to build bombs and blow them up? Is it “efficient” to build roads and infrastructure? Is it “efficient” to pay someone a temporary income after they have lost their job?

    This stuff gets tricky because you get into the realm of what is good at a productive economic level vs what is good at a personal or social level. I don’t have the answer there.

  • Cullen Roche

    No, borrowing and repaying a loan are two different operations. You’re essentially saying they’re the same thing. That makes no sense and doesn’t help anyone understand anything.

    Besides, your point is 100% debunked by using MBS. Would you say that Fannie Mae’s issuance of MBS monetized the US govt’s debt and financed the deficit? Of course you wouldn’t because that would be totally wrong and misleading. But that’s basically what you’re saying. You just don’t like to talk about MBS because it’s an inconvenient flaw in your thinking.

    You have to break this stuff down in more detail. Again, you’ve been making this mistake for a year now and I don’t know how else to more succinctly help you understand it.

  • LeftCoastIndependent

    First, the pain of the national debt hasn’t been felt yet because govt. keeps rolling over and refinancing the existing debt. 40% of the Federal budget is borrowed money and if we were to say no more, got to pay as we go, then the pain will be felt through lower services and/or higher taxes.
    Second, if the FED holds onto all those bonds until maturity, they will be paid off. But because all profits from the FED go to the U S Treasury, all the interest paid on those bonds will be returned to the govt., in effect a free loan to the govt. That’s the way I see it anyway. Someone correct me if I’m wrong.

  • Cullen Roche

    Well, debt doesn’t really get “paid back” in any meaningful sense over the long-term whether it’s private or public debt. In a credit based monetary system debt expands pretty much all the time over the long-term. The question is not whether we will pay back the debt, but whether the govt’s spending programs are positively or negatively influencing the economy. That’s where the debate is. It’s not about whether we can “afford” the national debt.

  • Suvy

    Wouldn’t bankruptcies push down rates? An inverted yield curve means that people are having difficulty making payments. If you have higher rates at the long end of the curve, that’s the exact opposite of an inverted yield curve. Flat yield curves across the ZLB are a sign that money is very tight.

  • Andrea Malagoli

    To your point, there is an insane charade going on all over Europe, where the sovereign spreads over the bundt are used as a proxy for economic health.
    Italian spreads are now at historical lows in the middle of a contracting economy and failing banks like MPS. Yet, the prime minister celebrates the low spread as a sign that the economy is about to take off. The PIIGS are still in the same amount of trouble as at the beginning of the crisis, if not worse, but you have seen their spreads shrink and equities rally based on nothing more than ECB machinations (in conspiracy with the sovereign governments).

  • Johnny Evers

    Look, I am a layman here, I admit this.
    Is it really established economics that lending is two distinct operations that should be looked at separately?
    It would seem that a loan has two parts — the issuance and the paying back (or the default or rolling over.) Nobody makes or accepts a loan without considering the second part. It’s the second part that is most critical, after all.
    As I said before, a federal loan might be a different animal, consisting only of issuing a T-bond.
    Are you saying that? MBA is a different operation. Let’s stick to this one.

  • Johnny Evers

    When debt expands faster than economic conditions warrant, or faster than the lenders can be paid back, a contraction results.
    It might be severe, like the Great Depression; or mild, like our current Great Recession.
    Once deleveraging takes place, either because we spend a decade paying back the lenders, or we default and break the lenders, then we can go back to expanding debt again — but again, only if economic conditions warrant.
    The idea that debt expands ‘pretty much all the time’ is a mistake, imo.
    MR needs to examine how much debt can safely be issued and how these limits are enforced.

  • Cullen Roche

    Debt expands and contracts in the short-term, but over the long-term, debt expands.

  • Andrea Malagoli

    “In a credit based monetary system debt expands pretty much all the time over the long-term”

    Over the long term, this would intuitively mean that there should be some sort of equilibrium where debt should at expand at a rate that can be diluted via a “reasonable” level of inflation compatible with economic expansion. In a credit based (and sovereign) monetary system, the tradeoff is credit expansion vs inflation, as opposed to credit expansion vs default — in the long term that is.

    When debt expands faster than GDP, to Johnny’s point, the likely outcome is inflation in excess of “normal”, with “normal” to be further defined but supposedly a level of inflation that is associated with healthy economic growth. Either that or stagnating growth.

  • Cullen Roche

    I don’t know how relevant debt:gdp ratios really are. Japan’s experience from the last 20 years seems to have blown big holes in the idea that high debt:gdp ratios necessarily lead to high inflation.

    I think we need to inspect the specifics more closely.

  • Andrea Malagoli

    Agreed – there have to be some additional elements. In Japan, there could be elements like who owns the debt, demographics and a different growth model (as in non-growth). All of this does not seem to prevent decent, albeit modest, lifestyles, but return on capital seems impaired.

    Just guessing, I agree there is not a fully understood mechanism at play.

  • Andrea Malagoli

    Just one other consideration. In Japan, only the government is highly leveraged. The individuals are savers for the most. This could also play a role.

  • Nico

    -Banks lend out,which creates deposits.
    Is the full intrest rate on the transaction for the bank?
    -Have banks saving accounts for which they pay intrest to the private necessary to reinvest it?(bonds,stocks,…)
    -If the debt(private) at its maximum with respect to income is it so that the private can only grow through new inventions, new discoveries, better technology …?

  • JRM

    I really enjoyed this post. I’ve been wanting to read some of your primers for some time now. I agree strongly with your economics = politics point of view, but I do tend to think that the Keynesians and Monetarists have a bit more evidence on their side. Austrians strike me as having less to back up their position. However, my intuition leads me to think all three have something to contribute, such that in one situation a monetarist approach might be more appropriate vs a keynesian or austrian approach the next time around, based on variables we haven’t quantified yet (and may never.) Am interested if you agree, or if you think that there is no substantial differences in practical value behind the three schools of thought.

  • Cullen Roche

    Hi JRM,

    I think that’s pretty accurate. Austrians probably get less credit than they deserve because the Rothbardian extremist faction of the school tends to build some pretty unreasonable views into their understandings of things. There’s actually a lot to like in Austrian economics if you’re willing to overlook some of the extremist views. But I generally agree that the views of Keynesians and Monetarists have been validated to a much greater degree in recent years than most Austrian views.

    I think they all have some good contributions to make. I hate to pigeon-hole myself which is why I devised MR as a mainly operational view of things. By taking that focus we can understand the operational realities and then something armed with MR views can pick their policy preferences. You could agree with Austrian policies or Keynesian policies using MR. That’s the beauty of it in my view.

  • Droubal

    A great job of explaining these topics. My only concern is the feeling that government debt is not a problem. When money is created it is always associated with debt. That debt is never paid off. So, if a billion dollars is created, it will, at some point cost more than a billion in interest. If gov’t loses control of rates, that can be a problem. If debt growth is faster than economic growth that is a problem. Why did Greece go broke? They couldn’t pay their debt.
    Why did GM go broke? They also had too much debt. Same for Detroit. Of course the U.S. government can always create more money to service that debt, but at some point, under some conditions, does that not become a problem? Japan is the canary. They are growing debt rapidly in a stalled economy. How will that turn out? I have a difficult time believing it will end well. If it does, then I am a believer.

  • George

    Economics is not my thing, so this is not more than a humble question.

    Let’s assume we have 2 persons, A having 100$ in cash and 100$ worth of bonds, and B having 200$ in cash. And we have Fed. And we have a milk seller M, which has a limited Q quantity of milk. A and B need milk, so they try to buy as much milk as possible.

    In the first case, Fed does nothing. No matter if and how A and B will buy/sell their bonds, the amount of money they have is 300$. In the second case, Fed has a small QE program, they buy the bonds. A and B will have a total amount of 400$ in cash, available to be spent on milk. Couldn’t we say that in the second case chances are that the milk will be traded at a higher price than in the first case?

    Or my story has nothing to do with the real world? Or in this environment we are now, after a recession and having a deleverage taking place there are other forces/variables in the market?

  • Suvy

    Instead, it seems like the high debt/GDP ratios are leading to extremely low growth. I suspect Japan will run a 15% of GDP deficit and I also expect growth to be negative. NGDP has barely moved in 20+ years.

    Also, debt/GDP ratios don’t really matter; debt servicing costs/tax revenue ratios matter. For every 1% shift in inflation, you get about a 3-4% shift in tax revenues (the ratio should be the fiscal multiplier+1). If we assume a 1:1 shift in inflation and interest rates, then the government debt/tax revenue ratio determines the percentage shift in debt servicing costs. For example, if we assume government debt/tax revenue of 8, then the shift in debt servicing costs will be 8% if we assume 1% inflation and a 1% shift in interest rates.

    High levels of government debt can create a deathtrap where inflation leads to effective suicide. The only way for governments to service their debt becomes with larger and larger negative real interest rates. If we remember that the currency is an asset in international trade, then the value of the currency (indexed) is equal to the sum of the discounted present values of all the future real interest rates. So the stresses don’t show up in the bond market, which is usually being defended vigorously by the central bank. The stresses show up in the currency, which comes under major pressure.

  • KB

    I see a lot of “potential inflation” talk in the Q&A here. Quite contradictory to the tone of the post from few days ago.

    In that post, as I understood, the consensus was that, as inflation is not happening, the current monetary developments are not leading (and will not lead) to it. Here, the consensus is different. Inflation, even a considerable one is assumed to be a possibility (no mentioning of H….N word though).

    So, pundits, what is it? Inflation or not? Should we expect some? What magnitude?

  • Geoff

    George, I don’t think your example is realistic. Person B holds bonds because he wants to save, not buy more milk. If he suddenly wants to buy more milk, he can sell his bonds and use the proceeds to buy the milk. The sale would be Person B’s decision, not the Fed’s. Person B don’t need no Fed to buy his bonds.

    If you are assuming that the money supply is fixed, so that Person B can’t sell his bonds, that is also unrealistic. Money supply is driven largely by demand and will expand endogeniusly to meet the needs of the system.

  • Mr. Market

    #1, 2, 6 & 8 are indeed myths

    #3, 4, 5, 7 & 10 are NOT myths !!!

    10: Economics is a science. The science of human behaviour to changing circumstances.

  • Warming Hut

    To meaningfully discuss what is “efficient”, one needs to ask “Compared to what?”.

    Like time, efficiency is only precise when described as a measurement between at least two possibilities and like time, efficiency is unique to each possibility.

  • DanH

    Jesse doesn’t like your post too much:

    Then again, he seems to think you’re doing M M T which is pretty funny.

  • Warming Hut


    Instead of inflationary perhaps you mean debasing the currency? For it to be inflationary, you will somehow have to get that money into the hands of the public–and not just the upper .1% in order to raise velocity. With velocity of money at record lows, it would not matter how much money was printed. To be inflationary money printed must be spent in huge volumes on real goods and services in a way it can change hands. Without velocity there is no inflation. There is only currency debasement. Think Ghono in Zimbabwe or the monetary history of Argentina.

    I suppose to an investor, this might seem like nit picking, but it is pretty darned important to macro econ (opposite of orcam?)


  • Johnny Evers

    The era of debt getting ahead of economic conditions has led to stagnation in Japan and some real questions about its future; as well as stagnation in the U.S., especially for the middle class. The working class was broken 20 years ago.
    We keep looking for signs of inflation and overlook the damage that has already been done.

  • AYC

    Hi Cullen,

    I wonder if the same logic about the fallacy of composition regarding micro-to-macro also applies to the notion of “wasteful” spending. Doesn’t money spent into the economy circulate many times over? If Solyndra goes bust, but they provided income to their employees and suppliers which furthermore circulated into the hands of other businesses and their employees, was that spending really wasteful in the aggregate? Could it be that “wasteful” spending is always preferable to not spending at all?

  • AYC

    PS We have to be careful not to conflate “efficiency” with turning a profit. It’s contrary to the purpose of govt. to make a profit. Let’s not forget what the sectoral balances analysis tells us about the wisdom of govt. surpluses….

  • Cullen Roche

    It’s a strange rebuttal to the post. Especially considering that he thinks I am using the MMT framework (which I am definitely not).

    1) He should read my 70 page critique of MMT.

    2) He is actually defending the MMT position throughout that piece which states that all money is essentially state money issued by the consolidated Fed/Tsy. So he claims that MMT is “sophistry” in his headline, but then he actually defends what is basically the MMT view throughout his piece. He doesn’t seem to actually understand MMT, which is quite common.

    3) He’s obviously got no idea what Monetary Realism even is because he doesn’t even seem to understand the differences between MMT and MR. So I don’t know how much credibility this “critique” really carrries. It looks to me like it’s just based on some misunderstandings of what my framework even is. I mean, anyone who calls me an MMTer in their headline has not been paying attention to some of MR’s huge battles with MMT over the last 2 years. Not that they should, but if you’re going to critique someone’s work it helps to at least be up to snuff with their views. Right?

  • Cullen Roche

    You get into a lot of moving parts here. Is all spending good just because it generates incomes? I think you have to view this relative to real constraints and output. Govt spending could easily just lead to a country outstripping its real constraints and generating high inflation. In that case the higher income just generates higher inflation and reduces living standards. Of course, living standards is a tricky concept to begin with….

    Now, in an environment like the one from the last 5 years where credit markets were broken and there was substantial slack in the economy I think the spending helped bolster balance sheets and growth. But it really depends on the specific environment. I hate to paint with too broad of a brush.

  • KB

    No, not really.
    He provided some critique of your theses, step by step. Getting aside from general statements of “really understanding some theory”, you only mentioned his response to your first thesis, saying that he is incorrect.

    Yet, to me he seems to be correct. If private banks “create” money under license, rules, and supervision of the Fed, then it is essentially the Fed who is in control of printing. And control means that it’s really Fed who prints. I assume you are familiar with the concept of outsourcing. In monetary regard, this type of outsourcing is not very rare.

    I still hope to see your response to other Jesse critique

  • Tom Brown

    The science question is one I’m very interested in. I’m not sure economics really qualifies yet. But there’s a lot of problems in treating econ like science: more so, perhaps, than in any other discipline except maybe political science. It’s a very chaotic mechanism to study for one. Like meteorology for example: a huge system with lots of complex feedback loops, and lots of non-linear dynamics. I’m pretty sure we’ll never be able to predict the weather that well… but we can continue to make incremental improvements. We can add sensors and more computing power and higher fidelity models. We’ll continue to learn but it will be slow going.

    Economics is close to meteorology in it’s complexity (say that’s true for the sake of argument), and suffers from many of the same problems: butterfly effect, non-linearities, huge number of states, lack of adequate “sensors” to really identify/track the states of the system, model uncertainties, etc. The best econ could hope for is something like the state of the art in meteorology… however, I don’t think it will ever even get that far, and here’s why: feedback loops caused by the model itself! As soon as a model shows the slightest bit of promise, it’s results will be used to change the system being observed. And here’s why econ and poly sci are two of the worst fields in this regard: a lot depends on the outcome… so there will always be highly motivated individuals who try to gain an advantage with any new results. At least weather systems don’t care what we learn about them and are not really affected by our models. We may even get to the point where we can “control” the weather well enough to FORCE it to be more predictable.

    I think econ does have a future as a laboratory science, but its progress will be dependent on progress in understanding the human brain (in part). Just as with meteorology, where we’ve identified laws regulating the movement of gasses, and thermodynamics, etc, we’ll break down some simple econ components and figure out how they work. But putting the whole system together will always be dogged by the feedback loop and complexity problems.

    One of the simple things I think we’ll figure out before the end of the century is exactly how a human brain works…. or rather our machines will figure that out for us. It’s a matter of decades (at most) before we have the full functionality of a human brain running in silicon… it’ll pass the Turing test with flying colors because it’ll essentially BE a human. It’ll still be extremely difficult to predict with great accuracy the actions of any one particular human perhaps (similar to the weather prediction problem), but I think we’ll be able to build artificial human consciousnesses fairly readily. Next step: build “The Matrix”… societies of simulated humans interacting in an artificial environment. I think all that will happen (ethical considerations aside!… “Let’s run the torture case #453 again to see how the simulated subjects react in hour 7… but this time with red hot pokers”).

    Of course all the while we’re simulating one kind of human on the inside, new technology will be used to modify the brains of us people on the outside!.. so even there, the simulated world will never really catch up.

    So in short, assuming we don’t annihilate ourselves first, I think we’ll eventually be able to simulate a small economy inside “The Matrix” and identify causes and effects, and maybe even many fundamental “laws,” but this will never allow us to fully understand the real economy on the outside. You can’t build a complete model of “The Matrix” inside “The Matrix.” However our robot overlords will find the tools we develop very useful in controlling and/or exterminating us. :D

  • Cullen Roche

    That’s not a very realistic way to view the structure of the monetary system. For instance, the govt regulates who can and cannot distribute financial advice in the USA by issuing licenses. Does that mean the US government controls all financial advice in the USA? Of course not. I can distribute as much financial advice as I want. The fact that I have a license to do so simply means that the government regulates my activities to some degree. Big deal. The banking system is exactly the same. The govt issues licenses and determines who can and cannot issue money within the US payments system. That doesn’t mean the Fed issues all the money or that the money is all state money. It just means the govt regulates money. Big deal. You could construct a fantastically unrealistic view of the world using this “licensing” or regulatory perspective of the world. You could literally construct a view that the govt owns or controls everything just because they have some regulatory control. That’s madness. Especially in a country like the USA….

    Jesse is calling MMT sophistry in his headline and then he is specifically defending the MMT view on banks as being mere licensed money issuers. That is precisely the MMT position. So he’s agreeing with them while I disagree with both Jesse and MMT on this point. His position is obviously confused.

  • KB

    No it is not the same. I do not even know what to say, if you think that distributing investment advice and printing money is the same….. Try to print some money, and check what would be the result )

    A guy at the printing press that prints US dollars, is probably the only one who can truly say that he is doing the actual process of printing – he presses the button, and the money comes out! Yet anybody who says “no the fed does not print the money, that guy with the press does it”, would be considered inadequate.

    Private banks create credit. The government creates money.

  • KB

    And sorry, I can not debate the differences between MMT and MR, as I do not really know MMT. You probably correct about Jesse’s confusion regarding the theories specifics, but I think his argument about who prints the money is correct.

  • Cullen Roche

    Okay, so you don’t think bank deposits are money. I wholeheartedly disagree. In fact, I’d argue that the government doesn’t create any of the “real” money. They create facilitating forms of money. Outside money like reserves, cash and coins are all used in a modern monetary system to facilitate the use of bank deposit money. I think you’re making the same mistake MMT makes and the same mistake most macroeconomists make by formulating a world view that starts with the govt creating money. I just don’t agree. I think it’s the banks who create the real money and the govt has effectively outsourced money creation to these entities and supports them through its various policies and outside money creation….

  • RB

    What do you believe happens to that credit, once it is created? And how would you distinguish that from “money”?

  • Cullen Roche

    I clarify on this point here:

    Outside money isn’t the real money….We’ve all been duped into thinking that the govt creates the money.

  • KB


    Nowhere in my post did I say anything about the bank deposit.

    If I would say anything about the “facilitating forms of money” it would be that the bank deposits, and the whole banking system was created to facilitate the use of money, not the other way around….

    When you say “it’s the banks who create the real money and the govt has effectively outsourced money creation to these entities…” it just confirms what I said.

    The government outsources the money creation. Be it to some guy with printing press, gold smelter, or a bank with a computer. Different rules regulate this outsourcing, as different technologies are used. Yet, it is still the government’s domain, control, and function.

    Getting back to your investment advice example, the government in no way had outsourced to you that function. It is your own design and purpose. Not so with the money!

    A good example of non-government money (surrogate of some degree) creation would be bitcoin. But not USD!

  • Geoff

    KB, the Fed can only print Reserves. That’s it. Reserves are not very useful to you and me. Do you have any reserves? I sure don’t. As Cullen has repeatedly said, Reserves are just a facilitating part of the system to help banks settle transactions.

    Hey Cullen, how come I can’t sign in to this site anymore?

  • Cullen Roche

    Of course it’s of their own design! The Shadow banking system is basically one big system that creates various form of money within the banking system. Banks aren’t merely issuers of something the govt says they’re allowed to create. Banks create all sorts of forms of money. Heck, any private sector entity can create various forms of money. The main reason why bank money dominates is because of the networking effect of money and the fact that bank deposits just so happen to be widely accepted as a medium of exchange. If some crypto-currency became the dominant form of money issued by banks then the US govt would likely just regulate it and tax it. It would just be a crypto currency denominated in USDs. That doesn’t mean it’s a govt money. It just means it’s a privately created form of money that is regulated by the US govt and denominated in USD. Big deal. Govt regulation does not equate to state control of everything….

  • Warming Hut


    Issuance of a loan technically expands the money supply. Paying it back decreases it.

    The quickest way I can think of to help you get what Cullen is trying to elucidate is to think of where it comes from. If it comes from Congress, it is fiscal. If it comes from the Fed, it is monetary.

    Good work from the San Fran fed introducing monetary policy:

    The CBO’s Monthly Budget Review reflects what is considered fiscal policy.,1,3,7,8&cat=35&type=1

  • Tom Brown

    Shoot: I got a little carried away there… that should have gone in your Forum under “other.”

  • Cullen Roche

    The site was having a major spam attack last week so I had to lock down the admin file. Only admin can access it now which, unfortunately, locks out any user from logging in. If you want your avatar to show up you should create a gravatar at the link below and just use that for your email on the site comments box:

    Sorry for the inconvenience….

  • KB


    Whatever money are accepted by the US government for tax payment are the only and true money, and there are no other!

    Be serious, and, by the way, the money as mean of the payments to the government is your very own argument.

    The fiat is fungible, be it “inside” or “outside”. It may become different under some circumstances (which were present in the former USSR shortly before its death. we would not want to see such stuff here). Yet as of now it is the same.

    The means of money production are important for some cases, but they are irrelevant for our present discussion.

  • Warming Hut

    As an added note, I suggest googling Federal Reserve Independence and reading why these two are important to distinguish between.

    Letting those responsible for fiscal policy influence monetary policy has always ended badly.

  • RB

    “If private banks “create” money under license, rules, and supervision of the Fed, then it is essentially the Fed who is in control of printing. And control means that it’s really Fed who prints.”

    Not really, because the Fed isn’t directing credit creation. It isn’t mandating loan by Bank A to Party B, or that bank credit will expand by X percent for this year, etc.

    The ability to license, supervise, etc., only gets you so far, and it isn’t the same thing as mandating the creation of credit.

  • KB

    In the US, it gets denominated in the only legal tender – US dollar. It may also be denominated in other currencies, depending on the circumstances.

  • Cullen Roche

    “Whatever money are accepted by the US government for tax payment are the only and true money, and there are no other!”

    That’s the MMT claim. Earlier, you said that only banks only create credit. But I can pay my taxes with a credit card. So you’re contradicting yourself.

  • john-retailinvestor

    But what if the fed buys up all marketable securities? What then? How will it drive rates lower?

    But then again, rates would be irrelevant since all treasuries would be non-trading. It then sort of becomes an existential problem.

    But lest you dismiss this question, fed has already bought up nearly 3rd of all treasuries. what will the fed do if another big crisis arise?

  • Cullen Roche

    Establishing the unit of account is not the same as being the issuer of money….

  • KB


    What do you mean? “federal reserve note” inscribed on the cash in my wallet? It is quite useful for me. If it is not useful for you, I would gladly accept any amount you have!

  • Cullen Roche

    Where did that note come from? It came from someone who drew down a bank account….Cash doesn’t exist unless someone first has a bank account. I think you’re getting things backwards by assuming the cash came first. The cash comes second! It merely facilitates the use of a bank account.

  • Geoff

    Thanks. The spam attack indicates that your site has hit the big leagues.

    Congrats :)

  • KB

    You do not exist! You are just some digits in the computer, I have never seen you….. And for that matter, I do not exist for you, as you never saw me. I may be just a clever bot fooling around.

    The cash exists and it is real. It is green, and it is in my wallet.

    I am not getting things backward. Please, learn history 101. Banking, with all these credits, deposits, and such, was created in Italy less than two thousand years ago. Cash existed long before that.

  • Cullen Roche

    Money is not necessarily a physical thing. The fact that you can touch and feel some forms of money really has no bearing on what “money” is. For most of us, money is just a way of keeping records of accounts. That’s about it. The fact that it sometimes takes a physical form is rather meaningless in my view.

  • DanH

    That’s what I thought also. Thanks for confirming.

  • Tom Brown

    …and long before cash (coins) existed, credit existed. Barter did too, but credit was king. According to David Graeber anyway.

  • Geoff

    KB, right, I should have mentioned cash as well. However, the Fed can’t just hand you cash. It can’t drop cash from helicopters. Cash is driven by demand from people who like it for convenience. Cash is not “pushed” into the system by the Fed. It is “pulled” from the private sector. The Fed just accommodates.

    Besides,we are quickly becoming a cashless society. How will your argument stand up then?

  • KB

    Not necessary, I agree. It was just my response to the argument that it is not real or “secondary” to some other form of money. For you, because of your preferences, it may be, for somebody else it is the opposite.

    And it will be as the US government, who is the real and only issuer of money, directs. Which gets us back to the original argument.

  • KB


    you said “Fed can’t just hand you cash. It can’t drop cash from helicopters… ”

    But it can! First of all, we should discuss the government, not just the fed, which is all but its branch. The government can certainly hand cash. More than that it is actively practicing such giving.

    Subsidies, LT unemployment benefits, some education, some healthcare programs are just few of examples. More obvious to you would be international aid – giving in its pure form.

  • KB


    “…and long before cash (coins) existed, credit existed. Barter did too, but credit was king. According to David Graeber anyway.”

    But for what you referring, that credit is not the money. Even in modern times, if I borrow from you some stuff to return it later with or without some extra, it does not create any money, nor it related to money.

  • Geoff

    Are you saying that the US Treasury can print money? That would be news to me, the Trillion Dollar Platinum Coin notwithstanding. :)

  • Tom Brown

    KB, you might take a look at this:

    Just skip the text and go to the simplified balance sheets. Set D = Ut = 0 for simplicity.

    Then you don’t have to worry about the chicken and egg problem… which came 1st: cash or credit. You don’t even have to worry about what’s “real” money and you can skip the word “facilitate” if that bothers you.

    The aggregate balance sheets all balance, and the simple expressions which relate them are right there.

  • Paul

    >>> 5) QE is inflationary “money printing” and/or “debt monetization”.

    Doesn’t this depend on how they unwind their balance sheet? I thought all the MBS purchases were to pull bad loans out of the economy? (Otherwise what purpose is the swap?) To me that means they should take a loss when they sell them back, right? If they take a loss then there is some “money printing” right?

  • Auburn Parks

    You don’t think T-bonds are money, which is why you say the Govt doesn’t print money. The govt prints CB balances, I would classify CB balances as money, especially with a ZIRP in place.

  • Cullen Roche

    Reserves are money for banks to settle interbank payments primarily. The only reason we even have reserves is because there is a private banking system with the need for central clearing of payments made with bank deposits. If we had a one bank nationalized system there would be no such thing as “reserves” as all money would be outside money. Again, this reserve system simply facilitates the use of bank money. Starting with the state is a misleading version of modern money.

  • hangemhi

    I would say that deficits finance themselves. The deeper in debt the Gov goes, the more money the private sector has. The more money the private sector has, the more demand for bonds….. and around she goes. So there is no need for QE since deficits create the demand for themselves.

  • KB

    The platinum coin would still be the money )

    When I am talking about US government, I mean all and any of its branches. Actually, it’s Congress, who legally prints the money.

  • LVG

    How does the US Congress “print money”? What exactly do they do that involves the printing of money?

  • hangemhi

    and to my point to johnny above…. if the debt and interest rates are so high that the Gov is paying huge sums to bond holders…. those bond holders, who have shown a clear desire to save, now have more money to buy more bonds with. this obviously can’t go on forever and would cause inflation, but that’s not my point…. my point is the gov won’t run out of money…. deficits essentially self finance. The higher the debt goes, the more money available to pay for the debt.

    as for a run away debt…. once you realize run away Gov debt is also run away private sector savings….. all you need to do is tax the savings. Politicians like to say our grandchildren are going to pay for it…. but all we have to do is tax the uber-savers….. and while we’re at it, why not tax China via tariffs? They can simply give back their bonds to pay for it and viola the debt goes down and we kill another myth about China financing us

  • KB

    It’s in constitution, I do not remember the exact wording. They approve budgets, borrowing, and direct other money creation matters.

  • KB

    why not? Just try to establish your own, and make it a legal tender….

  • Warming Hut

    Inflation requires velocity of money. Debasing a currency does not. Printing more money does not lead to inflation if the money does not change hands lots of times, it can lead to currency debasement.

    Inflation is driven by purchasing things of real value. From people who also by real things from others who also spend it again.

    Simply creating more currency alone will not create inflation. It can fertilize the economy for inflation. But if everyone puts most new money they receive into savings or pay off debt, there will still be no inflation. Inflation will not happen until a lot of people with pent up demand get their hands on a load of spending power.

    Otherwise explain Japan. 250% Debt to GDP and persistent DEflation.

    BTW, I am commenting because what you originally wrote, Cullen, was beautifully put (no investing pun intended).

  • Cullen Roche

    Totally agree there. And it’s very hard to see lots of spending during a deleveraging cycle as we’ve experienced because income growth is so weak.

  • Explorer

    Can’t banks lend money and withdraw excess reserves as the other side of the transaction?

    Aren’t reserves just an account at the Fed which can be reduced in balance as required if there is an amount in excess of what is legally required?

    Or do you say that once an amount enters reserves it can never come out of the total of reserves in the banking system?

    I think banks can lend amounts which would otherwise constitute excess reserves. And if there is no interest paid on reserves then they would not create more money to lend, they would reduce excess reserves to lend. They would do this to increase the average return on assets by eliminating assets with zero returns ie excess reserve assets that attracted no interest. The Fed could return to a 0 interest on reserves situation as previously existed.

  • Tom Brown

    KB, I’m certainly no expert, but my understanding of the Sumerian/Babylonian economic system in the 3000 years preceding the invention of coins was that you did indeed have credit recorded in the temples. I think the “medium of account” was officially silver or grain or some such, but the temple based economy revolved around recorded credit (recorded, fortunately for us, on clay tablets). You could use it to buy a variety of goods.

    If anybody actually knows how the Sumerian temple economy worked, please speak up: I’m going off of one book that’s getting a little fuzzy in my memory at this point.

    But this I do recall pretty clearly: the “gift economies” that Graeber wrote about, which were a kind of proto-credit: unquantified credit basically. I admire your cow, you give it to me. Now I owe you something, and eventually I must pay. This is fraught with danger: if I pay you a cow, it’s kind of an insult: it means I want nothing more to do with you. If I pay you a chicken it means I’m a cheapskate, and you, as the cow giver, rise in social standing in comparison. If I repay you with two cows or a horse, now the onus is on you: suddenly you’re in MY debt!

    But the system was more flexible than simply borrowing something, and then returning the exact same thing. The point was people owed each other, and that was a kind of social glue I think. I might give you a couple of goats or I might have to marry your daughter. And apparently there was (is?) an opportunity to actually observe these gift economies in action: modern primitive societies the world over made use of them. I wonder if this kind of proto-credit was transferable: could A repay B by telling C to just pay B for him?

    Barter was something done with foreigners (on relatively rare occasions) and was not really part of the day to day village economy.

    So I guess the “money” in these primitive societies was kind of a collective awareness of who owed who what. Debts did not have to be repaid immediately or precisely.

    According to Graeber, the dark age economy was similar in that it was credit based, but now the debts and credits were precisely quantified in terms of the old, no longer minted, Roman coins. It was centuries before coins started being widely used again. Where were these debts recorded? That I’m not sure about, but probably not on clay tablets. I believe in some cases there were notches made on sticks (“Tally Sticks”). Probably others written down in books.

    Again, if there are any economic historians in the house to set my story straight, please do.

    Money in all it’s forms seems like a memory aid to recording debts and credits between individuals and entities. The media that’s used (if one is used at all) is not necessarily of primary importance. That’s my take!

  • Tom Brown

    Geoff, well the US Treasury actually does print the reserve notes: the Bureau of Engraving and Printing does it. Likewise the Mint mints the coins. Both are part of Tsy.

    Forgetting the coins for the moment, the trick is in the accounting: the notes are not sold to the Fed at face value, only for their production cost.

    But then you probably already knew that… I’m just being a nit picker!

  • Tom Brown

    “And if there is no interest paid on reserves then they would not create more money to lend, they would reduce excess reserves to lend.”

    Try increasing the variable “L” (for loans) in the spreadsheet in this post and see what happens:

    Also try playing with “C” (cash held by non-bank public)

  • Geoff

    Thanks, Tom! We have missed you around here.

    Yeah, the fact that the Treasury technically prints the notes is the main reason why I didn’t include cash the first time when I was talking about the Fed only printing Reserves. But as you say, it is really a technicality so I will concede that point to KB. The Fed does provide cash to the banks, when called upon to do so.

  • KB


    Sounds about right regarding Babylonians. Yet, I did not say there was no credit in those times.

    I was just referring to modern banking. And as you know a lot about Sumerian culture, you certainly should know some stuff about medieval Italy, trade republics, and birth of modern banking system.

    The key point is that at first credit was not monetized, as it is now. It was still barter. The credit, as a number of abstract accounting units, came much later.

  • hangemhi

    this is a sloppy statement IMHO…. you’re replying to a comment about the Fed Gov’s debt, and yet seem to be making a statement about the private sector’s debt. This is a pet peeve of mine – half the myths would die immediately if people knew to separate the two since they are apples and oranges

  • hangemhi

    i see my comment below Cullen’s but my reply was to JE

  • Tom Brown

    If you examine the balance sheets above the spreadsheet, you’ll notice that the commercial banks have (for the case that they do have excess reserves):

    $(F-C-Ut) reserves

    F = Fed held Tsy debt
    C = cash
    Ut = unspent Tsy funds

    Loans don’t factor in, but they do change the banks’ BS in other places of course. Set Ut = 0 for simplicity, and if F is fixed, then really it’s just C which determines the reserves held by the bank: how much cash the public holds.

  • hangemhi

    Japan’s private sector has such large savings in large part because the gov has large debt – remember gov debt is private sector savings. If Japan’s private sector started taking on debt (they would only do this because of a desire to spend in excess of their savings) they’d be out of their deflation.

  • hangemhi

    “the only way for governments to service their debt…”
    Really? What about taxes? And per my points above, why on earth pols only talk about taxing joe six pack and/or our grandchildren, when all you have to do is pull a Willy Lowman and tax where the money is, is beyond me. High gov debt means high private sector savings…. to wit, there is enormous savings in the US private sector right now….. NOT coincidentally when the gov has a large debt

  • Tom Brown

    … and if you take issue w/ my implicit assertion (in the above) that human consciousness is purely mechanical, then econ must look even more hopeless!

  • hangemhi

    Droubal – imho the reason the gov’s debt isn’t a problem is they are spending that money on the very entity it can tax. GM doesn’t have that ability, and while Detroit and Greece can tax, they can chase away the private sector to places they can’t tax. And while this isn’t a perfect example, you can also equate it to your wife loaning you money to spend on your own household. As time goes by your debt to your wife looks massive, but it’s really only an account of your past spending. Your wife doesn’t need or expect that money back.

  • Cullen Roche

    So long as the debt is denominated in a currency they can create there is no reason to think they can’t service it. Of course, if they can’t tax the private sector (for instance, let’s say private output collapses) then they’ve got a whole other problem. That’s actually an inflation problem. But the solvency issue (usually the result of borrowing in a foreign currency for whatever reason) is very different than an inflation problem.

  • hangemhi

    I read the first paragraph at jessie’s blog and had to stop before i lost more brain cells – he says since the gov gives the Fed/banks their license to print, that means the gov really does print money. LOL. My wife is a chiropractor, and since we’re married it is really me adjusting people’s backs. Or her parents since they raised her. good grief. he should read his own definition of sophistry and then look in the mirror

  • KB

    sophistries upon sophistries…

    I thought Cullen came with really bad example, when he compared his investment advice business to the fed/banking relationship, but then came you with your example!

    Marriage is a really strong bond, but Hangemhi, the banks cannot divorce the fed. They probably can cheat in money printing, yet I strongly believe they will be caught fast and destroyed with everybody involved going to jail.

    How would I express this in understandable terms… The government controls and owns every element of USD. It’s much stronger than marriage. It’s even much stronger than AAPL controlling iPhone business. And do not claim it’s not AAPL, it’s Foxcomm “prints” iPhones….

    More than that, the government has a lot of control over US banks creating credit if foreign currencies. Not close to saying the government prints those currencies, but yet…

    I really wish to see the moment when banks start to create credit in bitcoins. I wonder how would it start – will they create it out of “thin air” how some claim they do with USDs? Or they will have to have bitcoin “reserves”? That would be a nice experiment testing all money theories.

  • Loren

    The claim that this financial assets/capitals recovery trough QE would create jobs growth and income for the middle class/for the economy, e.g. general demand of mass production, is the greatest MYTH of all. QE, or in other words, the free supply of financial capital, and its effect on an economy with stagnant unemployment, low demand for goods and services, but huge demand for financial capital needed for assets recovery, is exactly what the 1% expected from FED – full recovery of their wealth losses during GFC, via massive redistribution of middle class income and wealth. This is reckless monetary policy. It will bite you soon or later if you are not in the criminal financial sector.

  • Cullen Roche

    A better example is the NFL and footballs. The NFL determines the rules of the games, hires the referees and determines where games can be played. But they don’t make the ball that the players use. They outsource it to Wilson. Wilson has the sole right to produce and profit from making footballs. Of course, the NFL could make them in-house, but they choose not to. They outsource it. This is precisely how modern banking works. Saying that the govt “controls and owns every element of USD” is highly misleading in my view.

  • KB

    Hmm, let’s try to approach this differently.

    Cullen, could you describe a hypothetical case, where you would agree that a central bank “prints/creates” money.

  • John Daschbach

    Cullen, that’s the best thing you have ever written that I have read.

    Some points could have been stronger or different:

    Macro economics and micro economics very distinct from each other. Micro economics is concerned with one (or a group) of economic agents gaining advantage vs the economic mean. Macro economics is about the economic mean (or median, or really distribution function).

    You did make this point, but it could be stronger. While we can’t save real productivity for very long (entropy does rule, but note that Rome is still using some incredible sewer systems built during the peak of the Roman empire) there is a difference between building roads or dams or … vs consuming plastic “trash” that is thrown away in minutes to days.

    The largest way we can save real productivity is through intellectual effort. One of the main drivers of this in the modern world has been the US government.

    The bank reserves part is a bit misleading. Banks don’t lend reserves, true. But in a rapidly expanding credit market reserves do matter, since banks have to meet reserver requirements. How much this matters is unclear. Banks with low reserves have to borrow in the Fed Funds Market in order to make more loans (but of course there have to exist banks with excess reserves since loans create deposits). Does this slow lending? It’s not at all clear, but if all banks have excess reserves, there is no reserve requirement limit on lending. The reasonable psychological risk analysis on this is that in the former case, a bank with low reserves has it’s situation somewhat under the scrutiny of the other banks it borrows from in the Fed Funds market, while in the latter case it doesn’t. The recent crisis would suggest the latter effect is minimal during the expansion phase, and becomes catastrophic when it seizes up.

    Although more complex, my recent passes through the data suggest that when the Fed raises the FFR by large amounts it ends up having an effect on business credit lines (because the prime rate is reasonably tightly coupled to the FFR). The effect on consumer credit appears, if measurable, very delayed. In the most recent financial crisis, the Fed raised the FFR by a factor of 5x and the increase in consumer (mostly mortgage) credit accelerated until the financial crisis.

    This would of course align with your views that the Fed makes policy mistakes, but I think it’s also true that the Fed has very blunt tools, and with larger, more centralized banks, there is even less power in it’s tools.

  • Cullen Roche

    Sure, if the Fed offered to buy bags of dirt for $100 a pop I would call that money printing. But the current laws don’t allow for that. The Fed mostly just performs asset swaps with the hope that it can influence the pvt sector in indirect ways.

  • Cullen Roche

    Thanks John! Great comment.

  • JWG

    If the Fed buys a MBS from a bank with a face value of $10M but a market value of $5M (due to defaults) for $10M (as it has been doing) it is monetizing a $5M deficit for the benefit of the bank. It isn’t a government deficit but it is a deficit.

  • KB

    Also, regarding NFL example. If we consider NFL as a state, then it controls games, not balls. “Balls” would be something like computer in money printing. And “money” in NFL example would be game rules and score.

    I believe you would not argue that NFL controls the rules and score.

  • Johnny Evers

    Warming, I understand the difference between fiscal and monetary policy.
    But it’s all government policy.
    And we’re still trying to separate an exercise that has two parts. If there was only one part, we would just issue T-bonds with no maturity. Or just issue deposits.
    Clearly the system’s design is that T-bonds are issued and then redeemed through tax receipts. That is the complete operation.
    But now the Fed has stepped in and decided to redeem the bonds itself.
    Why? I don’t think that’s clear yet.

  • KB

    It’s not the Fed.

    Its the government, and they actually do it all the time. Solyndra is a good example. In that case a bag of dirt fetched much more than $100.

    But I understand better now what you call money printing.

  • Cullen Roche

    We seem to disagree on what “money” is. I think money is bank deposits. You seem to think it’s reserves or cash. I don’t know how to resolve that disagreement though I find it pretty hard to understand how anyone in the modern electronic banking age doesn’t agree that bank deposits are money….

  • KB

    To me they both are money. It’s fiat world. Everything is fungible. As of now, credit is money. It may change though, and at a very inopportune moment. We saw quite a few cases recently when credit ceased to be money, and some when deposits ceased to be money. We have not seen cases when cash ceased to be money for a while, but it can happen.

  • Jonf

    The government prints or otherwise creates money to pay its bills, several trillion each year. At least I thought they did. I mean where else would they get all the drones and bombs and things? And Al Gore told me there were no lock boxes full of social security checks and then there’s medicare and such and unemployment and food stamps, and… And then households and individuals and businesses work and add to it and banks loan for things too. So money comes from everywhere it seems. We all use the government’s money, right? I mean we all use dollars not too many euros and such. If any one of those segments gets plugged up there will likely be a problem in due course sort of like unemployment.

    The amount actually printed is small compared to the total dollars every year in GDP and is used mostly as vault cash. Most of the transactions these days is via computer entry. A check is another way of effecting a computer transfer.

  • Cullen Roche

    “The government prints or otherwise creates money to pay its bills, several trillion each year.”

    Not exactly. Tsy can do that by taxing or selling bonds. It does mint new coins and sell them for their face value to the Fed. Plus it’s constantly recycling old coins, which it must buy back at face value as well. Plus it actually loses money on pennies and nickles (their production cost is higher than their face value).

    The Fed distributes all the outside money: coins, paper reserve notes, and electronic Fed deposits. For example, the Fed pays Tsy (the BEP specifically) for new paper reserve notes, but it only pays their production cost. It then sells those to banks for their face value.

    So the Fed issuing outside money and the Tsy collecting dollars to spend in the TGA have nothing to do with one another. The Fed doesn’t buy bonds directly from Tsy.

  • Cullen Roche

    Okay, but the Fed doesn’t control the supply of bank money as you originally stated. In fact, the Fed has very little control over how much bank money is issued. That is the crux of the point here. I am stating that private for profit banks actually control our monetary system while MMT, mainstream econ, you and Jesse are all claiming that the govt essentially controls it or that bank money isn’t the “real” money, but just a claim on state money or something. I don’t agree. I think the banks control it all and will do so until the govt takes their power away (if ever).

  • Suvy

    The problem with raising taxes is that increasing tax rates from 0-20% brings in more revenue than increasing tax rates from 20-40%. You also have to worry about capital flight when raising taxes. Eventually, you’ll run into Laffer limit issues.

    As for high government debt meaning high private sector savings, I’m not so sure. Instead of buying government bonds, people can buy equities, corporate bonds, foreign bonds, real assets, and all sorts of other things. I don’t buy that argument of holding high government bonds as “safe savings”. Anytime I hear anything like that is “safe”, I’m inclined to turn and run.

  • Loren

    Digital or computer money is still money, only it is a cheaper functional form of money. That means the government doesn’t not need to physically print money for the creation of more money. It is just enough to create them via computer click and to supply the private sector with them via expenditures or FED to “print” QE and to supply the banks with it for speculation on the stock markets. Even individual rarely need banknote and coins, they use credit card to pay almost everywhere, but they still pay with MONEY.

  • Johnny Evers

    He’s talking about taxing savings.
    But the idea that high government debt equals high savings is silly, like you say. Deficit spending merely takes one kind of savings and turns it into another kind.
    The deposits created are circulated in the lower and middle classes but somehow seem to be flowing upwards to the wealthy, where they inflate financial instruments.
    How do we keep that from happening?

  • Anon

    Have you been paying attention to what’s happening in Japan? Distinctly different operations? I would disagree.

  • Suvy

    QE is effectively just a currency war and it’s design is to give us negative real interest rates in order to push the savings rate higher. That’s exactly what it’s done.

  • Loren

    How would negative interest rate push the savings higher? This is a nonsense. The aim is just the opposite.

  • John Daschbach

    No, we don’t. There still exist (a few) local economies in the world (Western Nepal is one I’ve experienced, but there are many more) where economics hasn’t changed much in more than a thousand years. But I think these economies all exist very close to the sustenance level (the only equilibrium possible in economics).

    At a non-philosophical level, even these economies have to have real productive growth (producing food, shelter, and clothing, …) that matches any increase in population if they are living at the equilibrium sustenance level.

    The complaint many make against growth is based upon it consuming more real (hard or impossible to replace resources). But economic growth allows for human growth. An economy where every Joule of energy is consumed in staying alive has no religion, no art, no science, no culture.

  • Loren

    And in any war the top 1% get richer and the rest poorer.

  • Suvy

    It’s not nonsense. Households are net savers while businesses and governments are net borrowers. Remember that negative real interest rates transfer income/resources from net savers (households) to net borrowers (businesses and governments). National savings is just GDP minus consumption (S=Y-C). If we transfer income from households to businesses and governments, the household income share of GDP drops and households consume a much larger portion of their income than businesses and governments. So Y is growing faster than C, which means that the national savings rate is increasing.

  • Suvy

    I’m not saying QE is good or bad here. I’m merely saying that QE is effectively just an old school currency debasement.

  • hangemhi

    Suvy and JE – you seem to think I’m talking about QE…. I’m referring to deficits which DO add to the private sector’s net worth. Deficit spending requires the creation of a NFA (net financial asset) which adds savings to the private sector. You can argue that during private sector debt deleveraging money is also being destroyed, but deficits are still adding even if other areas are subtracting savings.

  • hangemhi

    Nice try KB, but I didn’t claim a perfect analogy….. just a good enough one to totally laugh at the mental contortions required in the first paragraph of that blog post where it was obvious the author had an agenda, and would say anything to be “right” rather than admit to obvious facts.

  • hangemhi

    you’re confusing gov spending, and what the Fed does. as if the Fed and Congress are one and the same. I don’t know why you can’t see the fallacy of your arguments

  • hangemhi

    Jonf – Cullen says money is recycled, rather than newly created. So it sure does feel like “money everywhere” when deficits are so huge.

    I’ve originally found the idea that money is recycled, vs. printed, during deficit spending to be a semantic point, but I can see where Cullen is coming from in wanting to be exactly accurate, and so I agree recycling of existing money is more accurate than “deficits = money printing”. But they sure are close since the gov “prints” a bond, to access existing money.

  • Antti K.

    11. Econs aka economically rational actors
    They do not exist. Almost nobody optimizes like that, not even under lab conditions, less so in real life. Proof is in the behavioral economics experiments.

    12. DSGE models
    Based on several provenly false premises (historically, econometrically and mathematically) and does not depict the real world accurately, most economists do NOT know the false premises and still there is no alternative mainstream model. Proof in original Arrow et al papers.

    13. Perfect information, perfect exchange, perfect substitutability
    All provenly wrong. Proof left to the reader.

    14. Markets price everything correctly (based on efficient frontier)
    This follows logically from previous and anybody who has studied bubbles knows.

    15. You can’ny foreser or recognize bubbles, except afterwards
    Yes you can, with high degree of stochastic certainty, see Didier Sornette et al.

  • Mr. Market

    BTW: The US defaulted on its debts in 1790.

  • Suvy

    Just because it adds to the NFA doesn’t mean that it adds to the private savings. That’s my point. People can buy other assets than just government bonds. I can add to my savings by buying government bonds, but I can do the same by buying corporate bonds, real assets, equities, foreign assets, and a whole host of other things. Also, government bonds aren’t “safe”. Anytime I hear an asset is “safe”, it’s safe to turn and run.

  • indignado

    I think we all agree that the situation with the PIIGS is worse today and that lower sovereign spreads are masking what are very destitute economies. I would argue that CB policies worldwide are enabling this situation and making it much worse. The situation in Europe is just one very clear example of the type of moral hazard being created via ZIRP and QE. The worldwide chase for yield with the blind faith that CBs can back stop all debt markets will end very badly IMO.

  • Greg

    “Just because it adds to the NFA doesn’t mean that it adds to the private savings.”

    Sure it does. The NFA is being saved by someone somewhere.
    It may be as an increase in a deposit it might be as a bond but if the NFA level increases, somewhere income isn’t being spent… yet….. which is saving.

    So if govt bonds aren’t safe, what is?

    I agree that nothing is risk free but there are degrees to be understood and govt debt (of the US govt) is the safest (in terms of not being defaulted on)

  • Suvy

    How can you look at the supply of NFAs without looking at the price of all the financial assets involved. If I increase NFAs by 10%, but the price of those assets falls by 10%, I’ve got less savings than when I started.

    Government bonds, with their current pricing, are about as negatively convex as they’ll ever be. Why would you wanna hold them? There’s very little upside and a lot of downside (inflation risk, maturity risk, and interest rate risk).

  • Conor

    11. Economics=Macroeconomics

  • Geoff

    Suvy, tbonds currently have a positive convexity.

  • Auburn Parks

    Cullen, all Govt spending and taxing (unless deficit spending, with T-bonds bought by banks with reserves only) is a net zero with respect to bank deposits. But the TSY only transacts in reserves, so there is always an increase in CB balances when the Govt deficit spends. I would call this “printing” money. After all, in the aggregate, T-bonds can’t be bought unless the underlying amount of reserves is increased by the Fed first.

  • Grady
  • Mr. Market

    And Jesse does an excellent job in shooting down Cullen’s thoughts.

  • Johnny Evers

    OK, I see that deficit spending adds to savings because it creates the NFA … but only if that NFA doesn’t have a liability.
    I think I have trouble because MR doesn’t define a T-bond as either a bond or as money, but as some kind of third entity that is a bond sometimes and money at other times.

    Let’s say a corporation issues a bond. Does that add to total savings? No, because, while it creates a financial instrument, that financial instrument is a liability to the corporation.
    It’s even simpler to think of me lending money to you and you giving me an IOU. You are merely using my money, but you have to give it back. Together we still have the same net worth.
    MR seems to indicate that T-bonds are not a liability to the federal govenment, because our total net worth has increased, but it won’t quite say that.

  • indignado

    Cullen, I understand that the fed is not going to use its balance sheet to purchase goods. This is very clear. However, what isn`t clear to me is how the size of their balance sheet is not important.

    Let`s take a hypothethical based on your bottomless barrel comparison. So the fed could buy up all of the MBS, student loans, car loans, small business loans, even the saving deposits from the banks and just replace them with reserves. All of these assets will be neatly taken off the banks balance sheets and the banks will be made whole with huge reserve accounts and no revenue streams. Then the banks could just engage in stock buy backs, pay out bonuses, up the dividends to stock holders and then wind down the size of their operations since if people aren`t borrowing ?

    If this requires another 10 trillion then so be it. As you said, all the reserves in the world can be pumped into the inside money system, but it will not affect real output. I understand your position on QE being that it serves no significant role in terms of the private sector BSR. I agree. I think QE has been and continues to be a very clear, well thought out policy to recapitalize the banking sector while passing all of the interest rate and solvency risk of the feds balance sheet on to the tax payers.

    If I understand you correctly, you believe that the fed is giving rewards (reserves) to the banking sector with no risk because the assets they have removed from the banks are out of the inside money system. However, if we fall into another recession & RE prices drop, credit growth stops, and defaults rise then the fed will need to be bailed out by the tax payer; they are levered about 80 times to 1 today.

    Again, I am a layman here, but the notion of this magical void of the feds balance sheet defies my common sense. If there is one thing I have learned as a small business owner it is that there is no free lunch & that somebody always pays the tab. In this case in won`t be the private banking sector or the tax collector. As the old saying goes, if you don`t know who the patsy is at the table then its you . :-)


  • Johnny Evers

    The idea that the Fed’s balance sheet sheet is a black hole is quite revolutionary and should be explored, imo.
    The idea I leap to is that the Fed could deleverage all of us in one fell swoop and get us all spending again and borrowing for future purchases instead of paying interest on past purchases …. although detractors would say that would create moral hazard, and maybe inflation, and some would say that they don’t want me to be deleveraged because my debt is their asset! In other words, they like owning me! They want me paying them interest for the use of the public money!
    At any rate, I would guess that the markets would in shock if they realized the Fed is not merely exchanging assets but buying them outright, and that the Fed’s balance sheet is just accounting fiction.

  • Suvy

    Geoff, look at the upside and the downside of a 5 year Treasury Bond right now. I gain around 1%. The price of the bond can only go up by a fixed amount and can only go up if interest rates move to 0%. However, I could lose a lot of money on the downside. They’re not positively convex; they’re negatively convex. In math, we’d say that government bonds are concave down and this is around the worst possible time to buy them. It’s even worse in japan.

    Government bonds aren’t these safe assets right now. They’re very, very risky.

  • Suvy

    That should be convex down, not concave down.

  • Geoff

    Suvy, I’ll respond below because it’s getting too f-ing skinny up here.

  • Geoff

    Suvy, convexity is the second derivative of duration. It is a measure of the price sensitivity of a bond relative to yield changes. In general, the lower the interest rate (or coupon), the higher the convexity. See here:

  • Grady

    I sure think so!

  • Suvy

    Convexity is the second derivative of the initial function. Convexity is basically a smile shape while concavity is a frown. Bonds are always convex down when looked at as a function of interest rates. The graph should look “inverted”, if you will. That means it’s convex down. If the second derivative of the initial function is bigger than 0, then it means that the graph at that point is convex. Bond prices are a decreasing, convex function of interest rates and remember that interest rates can only go until zero.

  • Geoff

    Suvy, you said that t-bonds have negative convexity. I’m saying they have positive convexity. Negative convexity normally applies to a bond with an embedded option. T-bonds have no such options.

  • Geoff

    MBS bonds can have negative convexity due to prepayment privileges.

  • Cullen Roche

    The Tsy only transacts in reserves AFTER it has obtained money from someone else. The Tsy is an operational currency user. This is how the laws are presently structured. And the State Theory of Money says that “money is a creature of law” so why does MMT just ignore the laws in place? It’s a great big contradiction.

  • Cullen Roche

    It’s actually not very good at all. Jesse thinks I am using MMT, which I am not. So he doesn’t even understand the basic framework I am using. You can’t criticize someone’s work if you don’t even know the most basic element of it. Anyone who says I am using MMT and then criticizes me is making a huge error. And in fact, while he calls MMT “sophistry” in his post, he actually defends their views. Not only does he not understand my points, but he doesn’t understand MMT’s points either. It’s kind of funny actually.

  • Cullen Roche

    The govt is just a big redistributor of money. It must obtain bank deposits by taxing before it can spend and credit someone’s account. If you follow the accounting there is a very specific flow of funds under the specific institutional design in place. The thing the govt “prints” during deficit spending is t-bonds.

    I think this is important to get the details right because under this view it becomes obvious that our monetary system is designed around private profit generating banks and not the govt as money issuer (as was intended).

  • Suvy

    I’m talking about convexity in a mathematical sense. They must be convex down through the entirety of the function. I’m not talking about convexity in the sense of finance or options. I’m talking about the way the price of the bond varies as a function of interest rates.

  • Geoff

    OK, thanks for the clarification. When it comes to bonds, convexity has a very specific meaning. It might be a good idea to use different wording to avoid any confusion. Perhaps you could say that the risk/reward profile of bonds is currently “asymmetric”?

  • justaluckyfool

    Quote,”The government really doesn’t “print money” in any meaningful sense. Most of the money in our monetary system exists because banks created it through the loan creation process. ”
    “There in lies the rub’, Why have we taken away “In God We Trust” our wealth and given that awesome power to Private For Profit Banks ? OK, we feared giving our sovereign government that power; so how has that worked for the 99%. Don’t you think it’s time to reconsider : “Whom do you trust?” and change -Who may issue and tax our money (the physical evidence of our wealth).

  • Suvy

    In mathematics, convexity implies nonlinearity and thus asymmetry. Basically, I’m saying that it’s a sucker’s bet to think that a 5 year bond at <2% is a "safe" investment. The whole argument of government debt providing "safe" assets for the private sector is a load of horseshit in my book. Why would anyone think that the level of asymmetry in government bonds is good? The only way is if we experience the Japanese type of stagnation which we're desperately trying to avoid. In other words, that line of thinking will lead us to the place that we don't wanna be.

  • John Daschbach

    This is just another example of people who base their views on ideological statements of others and refuse to think clearly.

    The Fed has had both huge and small impacts on the financial markets. Largest impacts were the discount window and Special Liquidity and Credit Facilities immediately following the onset of the crisis. These actions certainly saved the US from a true financial crisis (which has the potential to be far greater than the Great Depression because we are so much more developed). This was the only significant

    The idea that QE is the free supply of financial capital is so wrong it’s sad that there are people with such views. The Tsy market is so liquid ($500 Billion/day traded) that Tsy securities and cash are operationally very similar. Cash beyond personal accounts with FDIC insurance potentially carries more risk than Tsy securities (since much of it exists in the “shadow banking” sector initially in the form of commercial paper). In QE the Fed prints money, but it removes a NFA from the private sector (reversed when the security matures or is resold). The change in investment capital only changes to the extent that the Fed pays more for securities in the open market than would obtain without the Fed intervention. Since the Fed operations have coincided with mostly lower prices (higher rates during QE than non-QE periods) the net effect is most probably to reduce the supply of financial capital from the market.

    It appears you are arguing something else, not related to the facts or understanding the financial markets.

  • HankB

    I loved #10. Especially considering how much time modern economists spend just trolling eachother. Has anyone been paying attention to the online spats between Paul Krugman, Brad Delong, Scott Sumner and Noah Smith? Do these people even work? Or do they just gripe at one another for a living. It’s just political pandering and an attempt to prove whose political position is best. It’s not economics. It’s just petty BS. This is what modern economists do these days. What a waste of space.

  • SS

    Ha. Did you see the recent “argument” between Smith and Nassim Taleb on Twitter? This one was truly childish.

  • Joe_S

    Hi Cullen,

    Thanks for this payperson friendly write-up. I’ve spent the last 24 hours scouring your website and I can’t believe I had never come across it before. It’s a jewel of knowledge. Thanks so much for all the time and effort you put in here. What a great public service.


  • Auburn Parks

    Why are you bringing MMT up to me right now? I certainly didn’t mention it. I’m not arguing anything about changing the laws. Nothing I said in my comment was inaccurate. Digressing into your distaste for MMT has nothing to do with me or what I said. I never bring it up here, my individual statements stand or fall on their own merit, just like everyone else’s. So if you’d care to address my actual comment, let me rephrase the three claims I am making, and if you’d like to point out where the logic is wrong, I’d be interested in seeing your response.

    1) 97% of all spending by the TSY amounts to a net zero change in bank deposits. The 3% of deficit spending where banks get T-bonds with reserves only, add that amount of bank deposits into the system via the recipients of that Govt spending.

    2) The Govt transacts only in reserves. T–bonds can only be bought with reserves. The Govt is the monopoly supplier of reserves. So inside the reserve system, every accounting entry was issued by the Govt.

    3) Just like all the accounting entries on each individual banks balance sheet was necessarily created by that bank. You call the private bank accounting entries “money” but you do not consider the largest bank in the world’s accounting entries “money”. I don’t understand this view at all.

  • DH

    Agreed with point 6 that money printing does not cause hyperinflation. The money printing is an effect, not a cause. Peter Bernholz, who literally wrote the book on inflation (“Monetary Regimes and Inflation”), studied 29 historical cases of hyperinflation and concluded that their common element is excessive government deficits and debt.

  • Cullen Roche

    Auburn, let’s not pussy foot around the topic at hand. You stated the MMT position that reserves fund Tsy spending. MMTers are the only people in the world who hold this position so when you state it you’re obviously stating the MMT position even if you don’t mention MMT specifically. Also, I know you’re an MMT devotee. That’s fine. I don’t really care. But let’s not pretend that we don’t both know you’re an MMTer.

    1) We agree there. Most govt spending redistributes existing deposits.

    2) The govt does not “only transact” in reserves. The US Tsy has accounts at commercial banks where it also transacts with deposit accounts.

    3) I call reserves “outside money”. They are money that facilitates the real money, inside money. The reserve system used by the govt in some cases is simply a way for the govt to more efficiently transact and account for funds management. It is not the center of the monetary universe and certainly not the place where all money is created or destroyed. MMT and most mainstream economists act like reserves are the real money and that banks just issue some sort of derivative. I don’t think that’s right.

  • Cullen Roche

    Thanks Joe. You’re too kind. Glad you’re enjoying the site.

  • JWG

    “The govt doesn’t “print money” via deficit spending. It prints a bond.” And when the FED, which is an instrumentality of government, buys that bond (even in the secondary market rather than upon issuance) with ex nihilo keystroke dollars, the government prints money–electronically. The bond goes on the FED’s balance sheet, from whence it can be sold back into the marketin the future (thus absorbing liquidity and sterilizing the keystroke money creation) or held to maturity and then–poof! Unsterilized money creation.

  • Johnny Evers


  • Auburn Parks

    We both know that, I am not hiding anything. I simply don’t scream “MMT!!! MMT!!!” here out of respect for you. You are free to say whatever you like and I am free to continue to not bring it up explicitly.

    1) sweet

    2) Of course you are technically correct and my statement was a slight oversimplification. However, in my defense TT&L accounts were only recently created (by the Govt) for the express purpose of:

    “The Treasury Tax and Loan program, a joint undertaking of the Treasury and the Federal Reserve, is designed to manage federal tax receipts and stabilize the supply of reserves in the banking system.”

    3) Yes, reserves serve to accommodate bank deposit transactions. But they also serve to facilitate Govt money transactions. Seeing as Govt spending and taxing accounts for around 20% of GDP, $17T out of $58T in TCMDO (30%), is the largest transacter in the world, I would say that reserves serve a little greater purpose than just accommodating bank deposit transactions.

    The truth is yin and yang, neither system, inside or outside, can thrive all on its own. In the same sense as neither the capitalist nor laborer is more important, neither inside or outside is more important since they are interdependent. I would just say that of the two, only the public system can operate countercyclically or exogenously. And its Our collective responsibility to use the unique attributes of both systems fully. And right now we are using neither fully. As you well know, this can be easily remedied by simply expanding the Govt contribution until the business cycle no longer needs so much of it.

  • Geoff

    Understood, Suvy. In some ways, bonds are always asymmetric. There is little upside (the most you can hope for is to get your money back at maturity) versus 100% downside potential if there is default. :)

    That said, long t-bonds could still provide a very handsome return if the economy softens and yields drop from 3.90% to say 3.00%

  • Cullen Roche

    Just remember:

    As I explained to Johnny above, QE is not only performed with T-bonds. You would never call QE via MBS “money printing” because you would never connect it to deficit spending. So you guys are just cherry picking how you analyze this. Sometimes you conveniently attach it to bonds and deficit spending and in doing so you continually ignore the MBS purchases. That’s very sloppy in my view. You cannot combine fiscal policy and monetary policy in QE. And if you do you better include MBS purchases in your analysis and explain why you’re cherry picking how you describe “debt monetization”.

  • Odie

    Yes “poof” but no money creation; the exact opposite. The Fed will debit the account of the Treasury (reduce its liabilities) and cancel out the bond from its assets. The Fed balance sheet will contract. The Treasury will lose an asset (its deposit at the Fed) and a liability (its T-bond). Not any different than someone paying back their mortgage.

  • Cullen Roche

    Fair enough. One last thing though – privately held US domestic debt accounts for about 5% of the private sector’s net worth. The private sector’s balance sheet (which is the balance sheet that makes the economy go round and round) is almost exclusively made up of instruments issued inside the private sector. When you take the MMT view of things you begin to get this all backwards. And in fact, that’s what all of the S=I+(S-I) discussions were all about. MMT uses a definition of “net saving” that is actually “saving net of investment” or NFA issued by the govt. This is, sorry to be blunt, entirely wrong. Constructing a world view around net saving as NFA will lead you to focus on that 5% figure when it’s the 95% private sector component that just about always drives the economy. Get this backwards and you’ll misunderstand how the money system works.

    And yes, it’s all about balance. But this is not just “yin and yang”. Unless Yin is small (govt) and Yang is huge (private sector). When you take the MMT view you get the impression that Yin is huge when in fact, most MMTers just want Yin to be huge through their Job Guarantee and other policies. Maybe that’s right. Maybe the world would be a better place if we had a much larger and much more involved govt. But that’s not the world we have. And that’s what I do – I try to describe reality and educate people about what is, not what I want.

  • Odie

    Thanks Cullen. For our survival probably not but if we want to give all 7 billion earthlings a western lifestyle we will need A LOT of growth. Same if we want to keep the world population growing.

    The question I have is would our monetary system survive without growth? Without growth aggregate real return on capital would be 0%. How do you save for retirement then? And in what form? Currency would essentially be as good as a bond.

  • Cullen Roche

    Ding ding ding. The T-bond goes away if the bond matures. There isn’t “more money”. There are only less t-bonds. That’s all. Govt debt maturing is like a corporate bond maturing. There isn’t more money after this happens. There is only less corporate bonds and the same amount of “money”. The govt uses bonds to acquire money. If its bond mature then the bonds go away and the money remains.

  • Johnny Evers

    It’s not cherry picking.
    We are looking at the life of the Treasury bond.

    As for MBS, I suspect that if the Fed is buying worthless securities, then it has monetized that debt.
    Look at it this way — if I borrow a dollar from you, and you give me an IOU … and it looks like you won’t pay me back … but the Fed steps in and buys the IOU at full value, then certainly a deposit has been added to the system.
    Is that what the Fed did with MBS? The owners of MBS were stuck and the Fed saved them? I remember those MBS were trading very low — liquidity issue, or insolvency? We’d have to look and see if the Fed has been able to unload those MBS back into the market.

  • Cullen Roche

    The MBS weren’t “worthless”. They were govt guaranteed. People just overreacted because they didn’t understand this.

    Anyhow, I think we all know that you think the Fed is funding the US govt. I don’t see it that way. Oh well.

  • Qcl

    “…I’m not saying QE is good or bad here. I’m merely saying that QE is effectively just an old school currency debasement…”

    Didn’t work for Japan :) Did it?

  • Johnny Evers

    Has the Fed been selling them back into the market? Has the Fed been making money on them as they mature?
    I meant ‘worthless’ in the sense that without the government guarantee they were worth way less than par on the open market because the party at the other end wasn’t going to pay the owner back.
    When you say ‘government guarantee’ you pretty much prove my point, in that a government bond is always redeemable at par by Uncle Sam, which Ben Bernanke is demonstrating. He is showing us the reality of government debt.

  • John Daschbach

    On Cullen’s #10.

    I’m a scientist by training and career (Physical Chemistry/Chemical Physics).

    A wonderful saying in science is that the product of complexity x understanding is, at the limit, preserved. (Harvard PhD’s learn “less and less” about “more and more” and MIT PhD’s learn “more and more” about “less and less” is the most common metaphor).

    Is economics a science? To an experimental physical scientist (me) I could argue it’s not. We can’t test it scientifically. But two of the pinnacles of physics are astrophysics and high-energy physics. One designs experiments from what can be observed (postulating models against what can be observed) and the other from what can be constructed and then observed (postulating models against what is predicted vs what is observed).

    To an epidemiologist or biologist or climate researcher, or similar, economics is science. To a chemist or physicist it’s not. But along the curve that conserves (complexity X understanding) there are a lot of economics that satisfies being science.

    Cullen provides a good reference point along that trajectory in today’s environment, but not an academically completely robust one. Given the alternatives, I would place more weight with Cullen than almost any of the popular media. Perhaps the greatest strength he shows is an ability to change his thinking to reflect new/modified understanding.

    This is rare among financial pundits/bloggers/pontificators, …. If nothing else, PragCap is pragmatic. It’s sometimes overemphasizing a trend (e.g BSR) but it’s adaptable. That’s a good thing when complexity overwhelms understanding. Cullen has shown a remarkable ability to adapt to more rigorous thinking.

    His response to the “Biggest Myths” is a tour-de-force. It’s not Kalecki by any stretch of the imagination, but in our denuded space of economic thinking it’s a positive expose.

    Read, think, discuss, derive your own models.

    Write down the differential equations that correspond to your models. Solve them (mostly numerically). What does that tell you?

    If you can’t propose a differential equation to correspond to your model then what good is it?

  • Cullen Roche

    If you want to tell people that govt bonds and MBS are “money” then be my guest. It’s not right in my opinion.

  • Johnny Evers

    You are always saying that the U.S. isn’t Greece because we have a printing press.
    Well, here it is …. QE.
    We were never going to directly print money because that would panic the market. But we can buy government debt on the secondary market and make it go away.
    It’s the way forward.
    This is a good thing!
    What if Greece could get the European Central bank to buy up its debt?
    It can’t because the Euro central bank doesn’t work for Greece.

  • Auburn Parks

    Cullen, what is more important, your mitochondrial DNA (small) or your skin (big)?

    Of course neither are more important since you wouldn’t be alive without both of them.

    Everyone is entitled to think what they like about their preferred composition of GDP. But if Govt spent $1 trillion more next year than this year on NASA and NIH scientists, solar panel and wind farm contractors and taxes remained the same, the economy would have more activity than it has today, thats just the simple math of it. We don’t control the private sector’s actions directly, only Govt actions.

    You think I focus too much on the Govt side and I think you focus too little on exogenous actions. Who’s right? Agree to disagree.

  • Tom Brown

    Auburn, take a look at the CB’s balance sheets in this post (both case 1 and case 2):

    I think that’s all correct given my simplifying assumptions. Note the CB’s BS dependence on T: the debt of Tsy (set Ut = D = 0 for simplicity). So while creation and destruction of reserves is part of the deficit spending process, the end result is not an expansion of the CB’s BS unless the CB ends up buying a net positive amount of Tsy bonds in the process, which is not really connected with Tsy deficit spending.

    Maybe you and Cullen already hashed all that out… I’m not sure (I didn’t read all the comments between you two).

  • Suvy

    Yea, that’s realistic. Getting the US Congress to be sensible. It doesn’t happen very often and hasn’t happened in at least 3-4 decades.

  • Suvy

    I wouldn’t say that the asymmetry in bonds always works in that direction. What if you were trading junk debt where interest rates for 10 year bonds were 20%? In that case, the interest rates definitely work in your favor. In the US, the 10 year was >10% in 1980. In those scenarios, there’s a lot of upside. In both of those cases, being long a bond is a very similar payoff to being long a call option.

    I’m not saying that T-bonds are a good or bad investment right now and I actually think yields are headed lower, but that’s besides the point. Just be wary when someone says that it’s “safe” and that deficit spending provides a “safe” asset for the private sector. Remember that the “safe” asset has a lot of downside risk that’s completely hidden in the left tail. In some sense, it’s like being short a put in a scenario where interest rates spike or if inflation spikes or something of the sort.

  • Suvy

    What are you talking about? The Yen depreciated 30% last year after their new QE program. They tried QE from 2001-2005, but it was very small and they dialed it all back too. They didn’t do any real currency debasement until 2012 and the Yen has fallen 30%. That’s a 30% decline in the real purchasing power of the Japanese public.

  • Cullen Roche

    The problem is that you’re implying that QE is some sort of savior that stops us from insolvency or saved the economy from the brink of disaster. I think you have to be more specific than that. Anyhow, gotta run. Take care.

  • Cullen Roche

    If economic prosperity were as easy as govt spending then lots of defunct authoritarian regimes would be the largest economies in the world….The USA didn’t get to where it is because its govt spends a lot of money. It got to where it is because it harnessed a beautiful balance between govt and private growth. That doesn’t mean govt spending is always bad, but I think we start to lose perspective when we start thinking that govt spending can fix all of our problems. Three’s so much exorbitant privilege in MMT’s discussions about the USA….I just don’t think it’s very balanced. I hate to be so critical of MMT because it’s such an interesting and useful paradigm, but there’s some overreach here that is unnecessary.

  • Auburn Parks

    I agree with alot of what you wrote here, not sure what it has to do with what I’ve been talking about. I don’t want to be put in the position of defending every perceived MMT claim you criticize.

    I simply stated the obvious, that a $1 trillion increase in net spending would produce more output than the current baseline. Thats a non-controversial objective fact.

    We can argue about opportunity costs, ways of paying, who to pay, should we even spend the money, spend more or some but less. cut taxes, increase spending, cut capital gains or income or payroll taxes and on and on forever. We could argue about all of this and more. But the one thing we can’t argue about is my specific statement:

    “$1 trillion more next year than this year…and taxes remained the same, the economy would have more activity than it has today,”

  • Auburn Parks

    Hey Tom,
    All T-bonds are bought with reserves.
    So in effect there are $17T worth of T-bonds that were at some point reserves. And in the aggregate those reserves will forever stay in the securities column until we run surpluses.
    T-bond sales drain reserves deficit spending adds reserve. Thats why they net to zero and “real” level of reserves basically remained unchanged for decades and decades until QE even though the economy, money supply aka debt, and GDP have grown exponentially.

    Thats all I meant initially.

    Thanks too to JKH for making such a good post about the number of reserves and operationally how little excess reserves the system has maintained over the years.

  • JWG

    Bonds can pay interest coupons and return principal at maturity. Or, bonds can pay both principal and interest and amortize to zero principal at maturity. Those that amortize have a discounted net present value of the future P&I cash flow over time; those that don’t have a discounted NPV of the future interest cash flow and the return of capital in the future.

    When the Fed creates keystroke money and purchases assets with it, the government is creating money out of thin air that didn’t exist before to buy assets that did exist before. The Fed holding to maturity, as opposed to selling the assets back into the market, results in unsterilized money creation.

    QE adds money to the system; what that money buys really matters to the system. The FED has the legal power to buy pretty much whatever it wants in an emergency. If the GFC destroyed enough asset values, then unsterilized money creation by the FED might be just what we needed. So far, it seems to have worked.

    I recall that the flash crash a few years ago was closely correlated with the FED taking tentative steps to reduce its balance sheet by selling some MBS back into the market. Hold to maturity makes a huge difference. The asset class purchased by the FED makes a huge difference.

  • Cullen Roche

    We all agree that QE changes the composition of the private sector’s balance sheet. I don’t know why you guys feel the need to connect this to fiscal policy though. What is the point? Why not just treat QE as its own monetary operation? I just don’t see the point of all this fuss about QE and fiscal policy.

  • Qcl

    They started agressively buying foreign exchange and this was the reason behind this depreciation not QE.

  • Suvy

    Not really. Japanese FX reserves haven’t really moved a whole lot. You’ve gotta remember that any time you impact the term structure of interest rates, you must impact the currency. Remember that the currency is an asset in international trade.

  • Suvy

    Yea, since 2012, Japanese FX reserves of have basically been flat. The reason Japanese people are moving their capital out of the country is because it’s the smart thing to do. The value of a currency is equal to the sum of the discounted present value of all the expected future real interest rates (if you view the currency as an asset). When expectations of future real interest rates shift, the value of the currency should also shift.

  • Kevin Cotter

    “I see the Cullen Roche is back at it again, telling us all about the wonders of modern money.”

    I love Jesse’s blog but that pissed me off. Lot’s of notoriety has been had the last 5 years from bashing our economic system and hashing blame at everyone in sight. I for one have found Cullen’s views refreshing and positive (even if I don’t understand or agree). Don’t ever apologize or change tact for not screaming at the bogeymen all the time Cullen. I want to see things as they are–not what I think or expect. Rock on dude.

  • unpaid debt screws someone over

    debt: a sum of money that is owed or due.

    Sure, you don’t have to pay back the debt. But whoever lent the money is going to be pissed.

    So go ahead and pay them back with more freshly minted currency and let’s see how long that lasts.

  • Mr. Market

    My gripe with Cullen’s views on the US financial system is that he thinks it was a brilliant design while in reality the financial system is the result of a VERY long (financial) evolution.
    Cullen’s views (MR) boil down to the notion of “We’re special”. Yes, that’s what e.g. the Soviets, the Nazis, the japanese, and the Australians think/thought.

    In that regard the US financial system is not different from e.g. the european financial system.

  • Johnny Evers

    A T-bond is not like a corporate bond at all.
    When a corporate bond is issued, and then matures, there is exactly the same amount of ‘money’ in the system.
    The bond is issued, I buy the bond, the bond matures and the corporation gives me the money back.
    In a T-bond, during QE, I buy the bond, and when it matures, the Fed gives me money. But the public still has my original money.

    I’ll quote hangemhi:
    ‘The deeper in debt the Gov goes, the more money the private sector has. ‘
    End quote. T-bonds are money.

    Cullen says the deficit spending adds NFA; he says that QE exchanges NFA for deposits … but he won’t add one plus one and admit that deficit spending with QE adds net deposits.

  • Ramanan



    Point 10 … you club Keynesianism together with Monetarism and Austrianism. Since when is the claim that government spending increases output unscientific? It is a rejection of the neutrality of fiscal policy asserted by others?

    So Keynesianism is a “bias” – what is a non-biased view then?

  • Billiejones

    Well Said. I completely agree. Cullen’s views are very thoughtful and well laid out. I also don’t agree with all of it….but then again, there aren’t any analysts/bloggers that I 100% agree with. Keep up the good work Cullen, its appreciated.

  • Odie

    “In a T-bond, during QE, I buy the bond, and when it matures, the Fed gives me money. But the public still has my original money.”

    Sorry but that is utter nonsense. You buy a T-bond and the treasury gets the money. The Fed buys it from you and issues new money in amount of the bond in your bank account. Once bond matures Fed debits the Treasury account and takes the bond of its books (balance sheet contraction). Beginning: You had the bond value. Fed and Treasury at 0. End: You have the bond value. Fed and Treasury at 0. New money = 0.

  • Johnny Evers

    ‘Once bond matures Fed debits the Treasury account.’

    Describe that to me. When the bond matures at the Fed, the Treasury has an account and sends money to the Fed? Where does that Treasury get that deposit?

  • Odie

    The Treasury does not need to send anything; it has its account at the Fed. The Fed just subtracts the bond amount from the Treasury balance and “destroys” the bond. Try this: Instead of Fed and Treasury replace it with “bank” and “homeowner with mortgage”. Have the homeowner pay back the mortgage; works the same way.

    Assuming the Treasury did not anything with the money: That is the same one it received from you when you bought the T-bond. Practically, of course, it will have spent that buy now and taxed it back or issued a new bond.

  • Johnny Evers

    It is still completely unlike a corporate bond.
    Corporate bond: Company issues bond and collects my deposit, then pays me back and bonds is destroyed.
    Net result, through the full cycle — no change in deposits.
    Treasury bond with QE: Bond issued and deposit collected, QE sends deposit to bond holder and bond is eventually destroyed.
    Net result, through the full cycle, an extra deposit is created.

    Thought experiment: What if the Fed bought *corporate bonds*? Wouldn’t corporations issue bonds like crazy, knowing they didn’t have to redeem them?

  • Indignado

    Cullen, if you have severe deflation, the collapse of credit, then outside money is higher on the degree of moneyness, right. Your model of the inside money system leading the money ladder is based on a perpetual growth credit/debt machine. If the world can continue to churn out more and more debt, then your model seems right on.

    Your model does not however take into consideration real deflation where currency would be higher on the money chain, because credit would be contracting and consequently defaults rising. In this regard, I agree with KB.

  • Odie

    No extra deposit is created. The deposit the Treasury collected is destroyed! The only deposit remaining will be the one in your account which you also had to begin with. Bond issuers have to redeem bonds to the Fed like any other entity. Otherwise the Fed would write-off bonds; that would be money printing but it does not do that (so far).

    Simplified (only assets; T-bond of $1 million):
    1) Start: You: $1 M; Tsy: 0; Fed: 0
    2) Buy bond: You: Bond; Tsy: $1 M; Fed: 0
    3) QE: You: $1 M; Tsy: $1 M; Fed: Bond
    4) Maturity: You: $1 M; Tsy: 0; Fed: 0

    1) = 4) Clear now?

  • Geoff

    There is no ladder, or hierarchy of money in MR. Only a horizontal scale.

  • Cullen Roche

    If the govt doesn’t rollover the debt then the deficit is declining and perhaps moving into surplus which reduces NFA. It’s the same as a corporate bond retirement. You’re just assuming that there’s always a budget deficit and that the debt is always rolling over. But you’re not considering the counterfactual where the Fed implements QE with a budget surplus. That would mean NFA is being reduced and debt is being paid down.

  • Cullen Roche

    I don’t think you’re getting this right. Your mistake is that you’re assuming there is always a budget deficit. You’re essentially confusing stocks and flows.

  • Johnny Evers

    In Step 2), as you say, the Treasury has $1m, which is spent into the public.
    So in Step 4), you need to add that the public has $1m. 1+1=2.

    Simplified (only assets; T-bond of $1 million):
    1) Start: You: $1 M; Tsy: 0; Fed: 0
    2) Buy bond: You: Bond; Tsy: $1 M; Fed: 0
    3) QE: You: $1 M; Tsy: $1 M; Fed: Bond
    4) Maturity: You: $1 M; Tsy: 0; Fed: 0

    1) = 4) Clear now?

  • JWG

    “Simplified (only assets; T-bond of $1 million):
    1) Start: You: $1 M; Tsy: 0; Fed: 0
    2) Buy bond: You: Bond; Tsy: $1 M; Fed: 0
    3) QE: You: $1 M; Tsy: $1 M; Fed: Bond
    4) Maturity: You: $1 M; Tsy: 0; Fed: 0″

    Odie, please explain again why four isn’t: “Maturity: You: $1 M; Tsy: 0; Fed: $1M (the principal amount of the bond at maturity) plus the value of all interest payments collected by the Fed on the bond in the past.” The fact that the Fed will remit these items back to Treasury just demonstrates the money creation ex nihilo. And in a deflationary bust, there’s nothing wrong with creating money to fill the hole dug by the bust.

  • JWG

    “The step transaction doctrine is a judicial doctrine in the United States that combines a series of formally separate steps, resulting in tax treatment as a single integrated event. The doctrine is often used in combination with other doctrines, such as substance over form.”

    What that means is, common sense dictates that sometimes monetary and fiscal operations should be analyzed together. Just because the FED must buy Treasuries in the secondary market rather than on new issuance doesn’t magically render the secondary market transaction transaction completely non-fiscal in net effect. You have to consider all of the moving parts as a whole and evaluate their net effect.

  • Cullen Roche

    No, it makes no difference. Step two would just be:

    2) Buy bond & Tsy Spends: You: Bond; Tsy: $0 ; Receipient of Spending: $1; Fed: 0

  • Odie

    In that case the Tsy has $0 at the time of maturity. Now it has two options: Issue new bond (roll-over debt) or tax the $1 M back. The Fed will want to see the money, in any case.

    In addition, that is a fiscal operation for which the Fed or QE is not needed. Just skip step 3 and you will see you end up at the same place as what you describe. You can recycle the $1 M numerous times, each time creating a new monetary asset (T-bond) in the private sector and a Tsy liability (government debt) without any Fed involvement. Or you want a balanced budget and tax the money back.

  • Johnny Evers

    If the Treasury does indeed take the 1million back from the public and send it to the Fed, where it will be destroyed with the bond, then, yes, no money will have been created.
    That would be 1+1=2 minus 1 = 1.
    But, seriously, that is pretend economics. Never going to happen. We can pretend that will happen so we don’t have to admit a deposit was created and our accounting adds to 1.
    Again, thought experiment: What if yo could borrow 1m and never pay it back. Wouldn’t your net worth be improved by 1m?
    Your description of the bond rolling over forever basically assumes the bond has no maturation. So again, the public has a deposit and the bond holders has a deposit, where in the begin only the bond holder had a deposit. Money creation.

  • Odie

    Because that is the way the accounting is done. When a loan is issued a bank creates a deposit (new money) together with the loan. When the loan is paid back the deposit gets destroyed together with the loan. The same operation just in reverse. That way all monetary assets = all monetary liabilities at any time in one economy (when proper accounting was done). If everyone would pay back their loans all monetary assets (including cash) would cease to exist.

    Not sure that satisfies you but that is how our monetary system operates.

  • Steve Roth

    On #1:

    This statement, and the problem it addresses, is rooted in the seemingly eternal problem of what different people mean by “money.”

    Economists have no standard definition, or really any coherent definition at all. It’s like talking about physics without a definition of energy.

    Here’s my definition:

    Exchange value embodied in financial assets — from dollar bills to CDOs.

    (Financial asset definition: an embodiment of exchange value that has no consumption/use value.)

    Use this term/definition technically, as a term of art, and dollar bills aren’t money. They’re embodiments of money.

    But: treasury bills are too. So are stock certificates. They’re all claims on real assets/real capital/future production (which are roughly, over time, the same thing).

    Just because banks print bank deposits (which seem more like “money” in the traditional vernacular sense) doesn’t mean that banks print money and government doesn’t.

    The failure to make that conceptual distinction lies at the root of much/most economic confusion.

    So I say yes: when the government issues new bonds (which embody money), they’re “printing money.”

    But over time, they don’t print nearly as much as the banks do.

  • Steve Roth

    And if we adopt this definition, just to see how it works, the quantity theory of money starts to make a lot more sense:

    (This is looking at total value of inflation-adjusted household assets. So to make this figure conceptually applicable using the definitions above, you have to say that a deed is a financial asset. Which isn’t crazy, I think…)

  • Cullen Roche

    HI Steve,

    Nice thoughts. I use a “scale of moneyness”. See here:

    This allows one to look at all financial assets as having a certain level of moneyness. Gold is money. T-bonds are money. Bank deposits are money, etc. It’s just that some forms of financial assets are the dominant means of payment. So something like bank deposits has a much higher level of moneyness than something like t-bonds. And in fact, t-bonds are sold in order for the govt to obtain something of higher moneyness (the bank deposits). This scale provides one with a much more flexible and realistic perspective on what money is in my opinion.

    I hope that clarifies the point.

  • Tom Brown

    Auburn, I think we’re saying the same thing. In theory, only a vanishingly small amount of reserves need ever exist to build up a huge government debt. Practically, the reserves levels will repeatedly grow and decline a moderate amount and accomplish this.

    For this purpose the reserves just act as a little bit of grease to get the T-bonds into the private sector. I agree this grease is needed.

    It’s not until the Fed starts permanently buying up large amounts assets (QE) that reserve levels really rise above this baseline level needed to keep the ball rolling.

    Also keep in mind that reserves are technically base money held by private banks. So if Tsy were to start accumulating a large surplus (unlikely) that would be a Fed liability, but they wouldn’t be reserves, since Fed deposits owned by Tsy are not “reserves.”

    Neither link you provided is working for me right now, BTW. I think the prob is on my end.

  • Tom Brown

    Say a bank issues you a credit card, and you’re a great credit risk and you rack up a large debt and never pay it off. That’s perfect for the bank! You’ll just keep paying interest and make them very happy.

    Sure they may have to temporarily borrow reserves somewhere to cover your debts, but that’s a spread they’ll probably be very happy with.

    Rather than being “pissed” the bank in this scenario will be happy if you never pay down your card… right up until just before you die. :D

    …and even then, they’d probably be happy to let your “estate” keep the debt… of course they don’t want to get stiffed with the principal payment in the end, but otherwise, they’ll be glad to let it ride forever.

  • Johnny Evers

    So you rack up a large debt and buy a car, let’s say, and then spend forever paying for the purchase, even after the car is junked.
    The bank has a permanent stream of income.
    Assuming your estate honors the debt, yes that’s a good deal for them.
    But is that a good deal for the individual? Is that a good deal for the economy, for a man’s labor to pay for a past standard of living? In the beginning, a loan brings spending forward but after a while it’s sends it backwards.
    I know you don’t think so, but we don’t really have effective tools to measure what’s a good loan and what’s a bad loan.

  • Odie

    It is only monetizing that bank deficit if it has to realize that loss meaning sell it for less than it acquired it for or write it off as the borrower does not pay it anymore AND the collateral (house) will recoup less than the remaining principal.

    Neither of those things apply, though, as the Fed pays market rates for MBS and buys only those that are guaranteed by federal “agencies” like Freddie Mac etc.

    The real problem for the Fed is the interest rate risk. It may have to sell the securities for less than it bought it for due to rising interest rates in the mean time. In that case, it may have to realize an operational loss. I don’t know the Federal Reserve Act well enough to know whether the treasury has to cover that loss. For the ECB it is no; it would just carry it forward and balance it another fiscal year.

  • justaluckyfool

    “”scale of moneyness”.

    Isn’t this really a scale of ‘exchange’ or a measure of rate of exchange- probability.
    Money itself is in no matter what form an asset that is always 100% convertible at par. A dollar can never buy two dollars (unless of course your a PFPB).
    The scale shows the degree that the present form varies when it needs to be “exchanged for ANYTHING”.
    Perhaps this is best shown when the banks found out that the MBS’s assets (moneyness) changed trillions into billions…if they were to be exchanged in 2009. The money did not change,but the exchange value of the notes sure did. BTW-this is perhaps the true causation of “systemic failure”. Using future money not yet created as a profit and not being able to replace it should that profit not occur.
    Greed: Getting your profit out before you make it. Why wait for the rule of 72?

  • Jared


    What do you make of these comments by the former Deputy Director of the U.S. Treasury about the sequence of government spending and bond sales?

    “[A]s a matter of practice, if the treasury wanted to disburse $20bn a given day, it started with at least that much in its fed account. Then later would issue new treasuries and rebuild its account at the fed… the explanation starts the cycle with government spending, thus adding to the money supply, and then issuing treasuries for roughly equivalent amount, thus restoring the money supply and the Treasury’s Fed account to the levels they were prior to that round of spending. Every cycle is: spend first, then issue treasuries to replenish the fed account. The fact that Treasury started the period with some legacy funds in its Fed account is not really relevant to understanding the current flow of funds in any year.”

    He seems to agree with the aspect of MMT which you find most problematic.

  • Steve Roth

    Colin, thanks. I remember that post, I spent quite a bit of time thinking about it. But here’s why I don’t think Koningness [grin] is conceptually tractable:

    (I first poked at this thinking over at his blog:

    In Koning’s construct, moneyness is synonymous with liquidity. A financial asset’s moneyness is determined by its “liquidity return” or “monetary convenience yield.” (And he’s done some interesting work teasing out how you can distinguish that yield from, for instance, capital gains/price returns.)

    But here’s where I think that breaks, starting with a couple of examples:

    Suppose you have $10k in quarters. You can buy all the Snickers bars you want; there’s a very liquid exchange market (quarters for snickers bars) out there. (Though need to tromp around to buy $10K worth of Snickers bars does seem to make it less “liquid”…)

    But can you buy a car with those quarters? How about treasury bonds? No. Those quarters are completely illiquid relative to cars and treasury bonds.

    Now think about treasury bonds. They’re completely illiquid relative to both snickers bars and, but extremely liquid relative to fed bank deposits (reserve balances) — if you have

    I don’t think I have to stretch this explanation out. Think about fed reserves/deposits — they’re (il)liquid relative to what other goods/assets?

    So every financial asset — in fact every real good as well — has multiple liquidities, relative to every other asset/good.

    And: the liquidity of many assets depends on who you are. If you’re a bank, your treasury bill is more liquid than if you’re an individual, cause the bank can trade it for reserves and the individual can’t. If the bank buys my bill for cash (bank or MM deposits), aggregate liquidity increases.

    So I prefer my definition, first because it is a definition. Defining “moneyness” as “liquidity” just begs the question. Define liquidity. Rabbit hole.

    The moneyness thinking doesn’t say what money is. Money is liquidity? I don’t think that’s coherent or useful.

    I’d be very interested to hear people put my bruited definition through some paces, see if it lets us think about this stuff better…

  • Steve Roth

    Ooops, why did I type Colin? Sorry, you know who I’m talking to….

  • JWG

    The FEd could conduct QE in a surplus situation by creating fresh money to purchase corporate bonds, mortgages, S&P Index funds, individual stocks–almost anything it wants (besides new Treasury issuance) in a self defined emergency under the Federal Reserve Act. Although it is on its face an asset swap, the Fed would undoubtedly be buying at non-market prices to fill a hole created by a deflationary bust–as it has done with MBS since QE started. It’s creating fresh money no matter how you slice it.

  • John Daschbach

    No, this conception of money wrong. You can derive a self-consistent theory of money from first principles on 1 sheet of paper. If you use the basic concepts of physics, then generally money (cash and digital deposits) and NFA’s (stock certificates, bonds, real estate, …, patents, copyrights, ….) are distinct and can’t be both be considered money.

    It’s true that we can construct a system where the set of all NFA’s includes money but then money has to obey the same rules as other NFA’s and not have a fixed conversion factor.

    In general, one derives a theory of money from considering a system without money. In such a system, all relationships between entities are described by individual contracts (e.g. I will give you 12 oranges today for 24 potatoes in 6 months). Money is introduced as an artificial auxiliary variable. In the sense of mathematics, it has zero measure, in the sense of physics it has zero mass (and hence zero energy). It’s just introducing a unit transformation (12 Oranges = 24 potatoes => 12 Oranges x $2/Orange = 24 potatoes x 1$/Orange => $1 = $1)

    Think of the limiting case. In an infinitesimal amount of time, all NFA’s have to be exchanged via transactions that involve money. The sum of the net value of all NFA’s is then equal to the sum of all money.

    Any theory of money that does not consider it to have zero value at the global macro economic level violates the First Law of Thermodynamics.

    The comment “So I say yes: when the government issues new bonds (which embody money), they’re “printing money.” shows that you don’t understand money. When the government issues new bonds, it is not creating any money. The amount of money in the system is absolutely unchanged at the moment the bond is issued. When a bank creates a loan, the amount of money is absolutely changed (increased). Not at all the same.

  • Qcl

    What about Euro denominated bonds ? They do not count as reserves. Do they?

  • Cullen Roche

    That’s just not how the cycle actually starts in most cases. The cycle of money creation starts with private banks. Banks create loans which create deposits. When the govt wants to spend it redistributes these deposits.

    If you use the MMT paradigm where taxes destroy the money and the deficit spending creates the money then you still need to account for the fact that most money creation in our system doesn’t actually start that way, but starts with the loan process. The loans create deposits and the govt just redistributes funds. In other words, if a bank creates a deposit through a loan then the borrower has a liability (the loan) and an asset (the deposit) and the bank has a liability (the deposit) and an asset (the loan). The loan is inextricably linked to a deposit from its creation to its repayment. So, when the govt taxes this deposit MMT will say the money gets “destroyed”, but this can’t be right because the deposit is attached to the loan that created it. Only loan repayment can really destroy the deposit. There’s a specific flow of funds in a credit based money system and most of the money creation starts with the private banking system, not the govt. Does that make sense?

    In theory, the govt could just create all of the deposits, but the current system isn’t designed that way. Govt is s redibstributor of money, not really a creator of the money. This puts inside money in the dominant position. So, even if you use the MMT position the whole system is still constructed around inside money (thought they wouldn’t describe it that way).

    If you start with the banks you get a much more realistic version of how most money actually comes into existence. That’s how I think of it anyhow.

  • Cullen Roche

    I think your definition is fine. Exchange value is perfectly compatible with my scale of moneyness. But you have to put it in the right perspective. For most of us, t-bonds have no exchange value. We can’t buy groceries with them. We can’t pay our taxes with them. We can’t do much except exchange them for deposits. Same goes for non-financial firms. So, the entities that comprise the majority of economic activity rely on something with higher exchange value. That is bank deposits in our monetary system. That’s why I place bank deposits as having the highest level of moneyness or the highest exchange value. T-bonds have high exchange value for financial firms, but financial firms aren’t a huge chunk of the real economy. So I wouldn’t place undue emphasis on t-bonds as money.

  • Qcl


    PV=FV x 1/(1+r)n

    Low rates support currency. This is what Warren Mosler claims as well

  • Detroit Dan

    Cullen doesn’t get (or has forgotten) the pyramid of liabilities concept —

    The central bank was created by the ruling class (those with money) to specifically sit atop the pyramid. The financial system would have collapsed in 2008 without the Fed creating money to “borrow” CDOs from commercial banks and insurers.

    I guess Cullen thinks hourly employees of a company have more power than the CEO because there are more of them…

  • Cullen Roche

    Please don’t be condescending with your nasty MMT attitude. I am tired of the inflammatory comments that MMTers always leave on my site and others. I get so sick and tired of having to deal with rude people on the internet and for some reason, MMTers tend to be among the rudest. Please try not to leave comments like this. Thanks.

    And no, I didn’t “forget” the pyramid of liabilities. I reject it because I think it is wrong.

  • John Daschbach

    I still think the primary problem with MMT vs MR is in completely different semantic uses for important words.

    At a very reductionist level, in MMT a government debt is the limiting case for the supply of money, and in MR limit is the amount of loans outstanding. I find the difference to be semantic. In MMT, money = irreducible NFA, in MR money = net private sector loans outstanding. Both are mostly correct. The total supply of money can’t go below the irreducible NFA, but this can only be balanced in the limit by private sector loans outstanding (or Fed holdings).

    But we don’t live at the irreducible limit. Thus MR is a much better description of the monetary system as it exists than MMT, even if through semantic transformations and taking mathematical limits they are roughly the same.

  • Greg

    I think the US got to where it was exactly because the govt spent lots of money…… on the right things. Sankowski and Beowulf have done many posts about the value and high level of govt investments the last century that have given us much of what we have today. Computers, rocket science, nuclear science, health care innovations, pharmaceuticals, energy”…… Non of theses would be where they are today if there were no public investments. We’d be living quite a few decades behind our current levels in my opinion

  • Odie


    That is not “pretend economics” that is what actually happens. You need to understand those operations to correctly judge the actions of the Fed and the government.
    “Again, thought experiment: What if yo could borrow 1m and never pay it back. Wouldn’t your net worth be improved by 1m?”
    Under strict accounting rules, no. Your net worth would be 0 as you would also keep the loan as liability. It may just not feel that way because you never want to pay it back.
    Important: all monetary assets = all monetary liabilities! Or in lay language: no money without debt. One group can only have net savings if another group has net debt. It then also follows that the net worth of a closed economy are all the non-monetary assets it acquired over the years. It cannot net save monetary assets.
    ” Your description of the bond rolling over forever basically assumes the bond has no maturation. So again, the public has a deposit and the bond holders has a deposit, where in the begin only the bond holder had a deposit. Money creation.”
    You have to be careful what you describe as money. The Treasury issues a bond which will create a monetary asset; not money. When it spends the deposit back into the private sector it could again issue another bond, spend the deposit and so on. Every time the Treasury would create another monetary asset for the private sector (and a non-monetary asset for our society; the thing it “buys”) while the deposit just gets passed around. Thus, government deficits create monetary assets (=savings) in the private sector and enhance our net worth. Why do we want that? Again some accounting: One person’s income is another person’s spending or: income = spending. However, spending = income minus savings. Thus, in any following time period the income would be lower by the amount saved (until people start to dis-save). To avoid the regression of the income, the savings need to be lend out. Hence: income = spending – savings + lending with savings = lending. It follows: income = spending (all without net money creation). Since people started to save a lot more since 2008 the government took on more debt to keep income (GDP) about equal. If you don’t want more government debt you either want less income or forego saving. If you want to reduce government debt you want to reduce the monetary savings of the private sector. As we live in a democracy we would then force ourselves through austerity to generate less non-monetary assets (less increase in net worth) and to dis-save.

  • Odie


    I would like to see the passages that allow the Fed to buy stocks etc. As far as I know, it buys its assets in open market operations for market rates. Please provide specific examples if you claim otherwise. At the moment it only buys treasuries and MBS that are as good as treasuries (backed by government guarantees) thereby replacing a bond with a deposit on the seller’s asset side.

    Why did it not create inflation? First, the value of assets of the seller stayed the same (except for changes due to falling interest rates). Second, those sellers are banks that don’t SPEND their assets. They need to keep those deposits to balance the liabilities they have towards their customers. The actual lending and spending took place when the bond was issued. Secondary market transactions have no bearing on GDP or price level (except for interest rate changes which may affect further lending and bank earnings).

  • unpaid debt screws someone over

    Say you get the rest of the world to buy your treasuries, and when it comes time to pay back the principal you sell more treasuries to pay back the principal.

    Then say one day the lenders want their principal back and they no longer want treasuries.

  • Cullen Roche

    Yes, the US govt has certainly spent money wisely. But I don’t know if I’d go so far as to claim that the govt is primarily responsible for the high standard of living. One of the great strengths that the USA has been able to harness is the way we use govt as a private sector partner. So I don’t think it’s necessarily one or the other here. Probably a bit of both with more emphasis on the private sector if I had to guess.

  • Suvy

    Yea, it depends on the term structure. You can’t just say rates without talking about the difference between short term and long term rates. In the case of short term rates, raising interest rates sharply raises the value of the currency.

    By the way, the expectation hypothesis of the term structure doesn’t hold empirically.

  • Suvy

    Japan has had positive real interest rates for the past 25 years. I said real interest rates, not nominal interest rates.

  • Odie

    And what exactly is the rest of the world doing with those $? They don’t know what to buy with it; that is the reason they buy treasuries and we have a trade deficit in the first place. If they just stuff it under their mattress: great! They just went from an interest-bearing asset to an interest-free asset; good for us.

    But if it is necessary the Fed will buy the treasuries and issue deposits. Then the treasury will have to pay the principal back to the Fed instead of to the foreign bond holder. If the treasury cannot roll over the debt they will have to increase taxes to cover that bond.

  • Suvy
  • Greg

    Hey Cullen

    When I say that the govt is primarily responsible for the high standard of living I don’t mean that govt officials or elected people made the crucial decisions in most cases I simply mean that the mass public investment created these things, or rather ALLOWED the private sector to create these things. The work is most assuredly done in most cases by privateer sector people, the investment is being made by a a public sector that is NOT looking for short term profits. Its the need to recoup profits in a short time frame that keeps most private sector sources of funds form making some very large investments it seems to me. They can actually run out of money before the goal is reached.

    I actually do not like the private sector/govt dichotomy the way it is used by many people. Govt SPENDS while private sector CREATES using that spending.

    I don’t think its hyperbolic at all to claim our standard of livings today are more a result of better energy delivery systems, better health systems, our computerized world etc, which would not be at the level they are without the public investment. Thats all Im saying.

  • Steve Roth

    “For most of us, t-bonds have no exchange value. We can’t buy groceries with them.”

    Right there, I think you’re falling into one of the two related conceptual traps I’m talking about: confusing money with things that are like currency (what we’ve traditionally thought of us “money”) — that have liquid markets relative to real goods.

    But of course a t-bill has exchange value, and is extremely liquid, but only relative to other financial assets. (This Koning post is a propos: I’d say it quite clearly embodies money.

    You often hear reserves talked about as “bank money.” That’s not bad, and I think it gets to my point: reserves do embody money, but they’re only liquid relative to other financial assets (and that only among Fed account holders).

    Do t-bills or reserves have more moneyness? I don’t think that’s a tractable or useful question — doesn’t lead to a coherent understanding of how money works.

    What is the exchange value of a financial asset, as designated in the unit of account (The Dollar [not "dollars], much like The Inch)?

    I think Koning is right that its liquidity is an important part of that value. But liquidity is a much more complex concept than he suggests, depending on the specific legal/institutional construct that creates that asset (where can it be traded and by whom, both legally and practically), who’s holding the asset, and the relative supply and demand for that set of trading rights and practical possibilities.

    Bank deposits clearly have the most widespread and fluid exchangeability. But I don’t think it makes any sense to say that they have the “highest exchange value.” I just don’t know what that means.

    Long story short, here’s a challenge: try writing posts without ever using the word “money.” This because, given the current state of non-definition, using it will just confuse your readers (and I would suggest, yourself).

    I’m not at all sure whether this suggestion will result in more conceptual clarity, but I think it very well might.

  • http://none J.J. Rodriguez

    “There seems to be this strange belief that a nation with a printing press whose debt is denominated in the currency it can print, can become insolvent. ”

    This is true only for the US, and who knows for how long. Had the Euro become a strong currency or if ever the Chinese get theirs to be so, there could be a run on the US currency that would make printing more money useless to pay debt. Behind the technical language that is used in the this blog, there is the assumption that the US will continue to be a Superpower able to deal with its economy with only minor concerns about the world economy.

  • Steve Roth

    “money … and NFA’s … can’t be both be considered money.”

    In this definition they’re not. (As I said, in this definition even dollar bills are not money.) They’re both embodiments of money.

    “we can construct a system where the set of all NFA’s includes money but then money has to obey the same rules as other NFA’s and not have a fixed conversion factor.”

    Again: this is confusing conceptual levels: by saying that NFAs can’t include “money,” you’re implicitly defining money a different way tied to a time-immemorial vernacular usage: as being similar to currency, i.e. easily exchangeable for real goods.

    I’m trying to cut that gordian knot — perhaps quixotically, but I think in a conceptually coherent manner…?

  • Steve Roth

    @John Daschbach:

    But also, you’re getting right to a point that I’ve been pondering a lot: financial assets that have what I call strict nominal stability: i.e, a dollar bill’s exchange value is always “1″ as designated in the dominant unit of account (The Dollar).

    Though that nominal stability is abrogatable. (cf my earlier on legal constructs and institutions that constitute a financial asset’s sine qua non.) See Miles’ Kimball’s thinking on electronic money and variable-value currency.

  • Vincent Cate

    There are many many cases of governments with printing presses that became insolvent. What they did was print so much currency that it was no longer accepted as money. The process is hyperinflation. Lots of historical examples.

  • Steve Roth

    Just one more example that I tend to ponder a lot: a million dollars in $100-dollar bills.

    If that stack of bills is in a Columbian drug dealer’s suitcase, it has a different exchange value than if it’s in a bank’s vault with legally sanctioned tally sheets designating it as the bank’s property.

    I don’t know quite how to deal with this conceptually, but I am pretty sure that I’m not alone in how to deal with this conceptually, and coherently.

    “Money” has yet to be properly theorized. (Including, very much, by me.) It’s like physicists talking about physics without a coherent theory or definition of energy.

    This theory and definition should be the opening chapter in every econ textbook. When the issue is even addressed, it’s only done via the incoherent thinking about three “mediums” (account, exchange, storage).

  • Steve Roth


    I think you’re confusing different meanings of “reserves”:

  • Odie

    That fixed exchange value is also true for most bonds. People seem to get confused about that because of a bonds changing value in the secondary market. Example: A 30-year mortgage with fixed rate. You can calculate today what will be the total amount paid until maturity. If interest rates rise in the mean time the value of the bond will fall as it will be more profitable to make a new loan at the higher rate but the total amount to be paid will not change. I like to think of a bond as a check with a draw-date in the future. Like a bond for $10,000 and 5% interest over one year will be a check over $10,500 with a draw-date one year from now. If you need that money earlier you may sell that check and if rates have risen since then you may sell it for less than $10,000. Does not change the $-value of the bond though. Thus, any bond with a set rate will exchange at a predefined amount into $. I like to call all those assets “monetary assets” as they are all embodiments of money at fixed exchange rates.

    And I agree with your initial comment that way too much emphasis is put on the distinction between “money” and “monetary assets”. If I have $10,000 in a CD or in my checking account does not change my net worth and therefore has little bearing on my spending decisions other than liquidity considerations. Net worth and income drive spending; not the ratio of deposits to financial assets.

  • Steve Roth

    “That fixed exchange value is also true for most bonds.”

    Very true — certainly for treasuries.

    “I like to call all those assets “monetary assets” as they are all embodiments of money at fixed exchange rates.”

    “too much emphasis is put on the distinction between “money” and “monetary assets”.

    That may be very useful language/thinking. Reserves would very much fit in that category.

    But it still leaves me wondering how to think about different financial assets’ liquidity, when that overall liquidity inevitably consists of liquidity relative to various other goods and assets. Could one construct a weighted index representing different financial assets’ … call it “combined liquidity”? Just noodling here…

  • Steve Roth

    A possible definition:

    “Monetary assets” are financial assets with rigid nominal stability. (At least historically, their exchange value at maturity (if the have maturity) correlates perfectly with the unit of account.)


  • Cullen Roche

    I don’t necessarily agree. I am exceedingly clear in my work that “money” is the thing with which you can utilize as the means of payment. It is the medium of exchange. Money is not just things that have liquidity relative to real goods. You could say stocks are “money” by that thinking. I don’t think that’s right at all.

    For most of us, “money” is bank deposits and cash/coins because it is the medium of exchange. For banks, it’s reserves. For a pawn shop it could be gold or other things. It depends. But the meaning is very clear and there’s no need to get overly complex. Different items can have properties of money as a medium of exchange depending on their situation.

    Financial assets are almost always issued to obtain the means of payment item. Stocks/bonds are issued to obtain the thing with which you can use in WalMart. T-bonds are no different. They are financial assets issued by the govt because the govt can’t spend balances into our accounts without having first taxed a bank deposit. This is a “self imposed” legal construct, but so what? We have rules that define the structure of the monetary system and I think it’s important to work within those rules as they actually exist. If the govt were the monetary issuer in a real sense then it wouldn’t need to issue T-bonds. It would simply credit accounts. It doesn’t actually do that under the present design so there’s a real rational and legal reason behind the issuance of t-bonds and this puts t-bonds on a very similar level to corporate bonds (though, obviously, of higher overall quality).

    This is all consistent with fairly mainstream thinking. I don’t think there’s a need to over complicate things.

  • Steve Roth

    “Net worth and income drive spending; not the ratio of deposits to financial assets.”

    I very much agree.

    1. People shift money into real-goods-exchangeable forms for two reasons:

    A. They are seeking nominal stability for their wealth.

    B. Because they want spend some of their wealth on real goods. The don’t spend on real goods because they’ve exchanged their wealth into goods-exchangeable form. This is the error I see in much monetarist thinking.

    2. (Sort of an aside.) A consumption function (like Keynes’) that does not include wealth/net worth as a term is useless.

  • Cullen Roche

    Excellent thoughts there Odie. I always like to say that spending is a function of income relative to desired saving. So “money” is not the most important driving factor in spending decisions. Instead, it is essentially income relative to net worth as you stated.

  • Steve Roth

    This is actually a pet peeve of mine: the notion of “spending out of income.” An incoherent concept.

    You can’t spend out of the moment of a person handing you a five-dollar bill (a flow). You can only spend out of the five dollar bill in your hand, pocket, or wallet (a stock).

    “Spending out of income” can be a useful shorthand for “the absolute difference or relative proportion, in a period, of income and expenditure.” Can be a useful measure for individuals, groups, sectors.

    But as commonly used, I find it to be a pernicious conceptual rabbit hole.

  • Steve Roth

    Pernicious at least because it distracts from what is at least equally, and arguably more, important: spending relative to wealth.

  • http://pragcap Michael Schofield

    LMAO Vincent! Nobody’s printing! As Cullen has pointed out a zillion times, public and private debt (debt in the aggregate) has to keep growing (growth in the money supply) in order for GDP to grow. That why there’s more money & prosperity. We’re OK, just sell that gold and buy some SPY shares, you’ll be fine too!

  • Cullen Roche

    There are degrees of autonomous currency issuers. For instance, is the nation a reserve currency issuer? Is the nation’s currency floating FX? Is the nation’s debt denominated in its own currency? Is the Tsy and Central bank relationship symbiotic? There are lots of nations that don’t meet these requirements, but the USA does. That could obviously change in the future….

  • Tom Brown

    Johnny, the claim was that a lender will be “pissed” if the borrower never pays the debt back.

    I was merely pointing out that’s not always true (as long as the borrower doesn’t actually default)

  • Steve Roth

    I would add a question: is there a fiscal union that ensures, through no-strings transfers, that no sections of the country (semi-sovereign non-currency-issuers, like US states and EU countries) go bankrupt?

    i.e. the US transferring hundreds of billions over the decades from blue (and urban) to red (and rural).

  • Geoff

    Don’t tell the Tea Party that their precious red states are free loading. :)

    I think Canada would basically fit your description of fiscal transfers with no strings attached (though there is no explicit guarantee that any province won’t default).

  • Steve Roth

    “Explicit” of course being the key word there.

  • Geoff

    True. Canadian provinces borrow billions of dollars in the bond markets based largely on the assumption that the Feds will bail them out if they were ever to get into trouble. It would be interesting to see that assumption tested.

  • Vincent Cate

    When Cullen says “a nation with a printing press can not run out of money” he really means the ability to make money, electronic other other. The point is the government can always borrow more if the central bank will always make money and buy their debt.

    The flaw in Cullen’s argument is that sometimes they make so much currency it stops being money. Does not matter if it is electronic or paper. If it is electronic it can later be converted to paper if banks/people so wish.

  • Cullen Roche


    I think you’re changing the topic though. Printing too much money is not the same as running out of money. You’re just talking about high inflation. I 100% agree that that can happen. What I am saying is that the US govt is unlikely to encounter such an environment and it’s certainly not at risk of a Grecian type solvency crisis where they literally can’t raise funds.

  • Geoff

    Grecian. :)

  • Steve Roth

    “income relative to net worth as you stated”

    Or — closely related, of course — expenditure relative to net worth.

    On that topic, are the two graphs at the end of this post interesting?

    Think: secular stagnation.

  • Cullen Roche

    Very interesting. I don’t know how much we can read into it though. How much of that decline in the two charts is just a function of rising house/stock prices? I don’t know what the conclusion would be. I’ve gotta think about that some more….

  • Steve Roth

    This raises the question of what financial assets (in toto) represent.

    First blush, they’re claims on real capital — and not just fixed or NIPA capital (or future production, which is kind of roughly the same thing — current capital value being present value of that future production).

    But what real capital? Only that which has been financially capitalized — from business’s drill presses to students’ future earnings, capitalized via student loans?

    But it’s the totality of real capital (including your vegetable garden, great idea for a new widget, and six-year-old’s musical talent, none of which have been explicitly monetized/capitalized) that serves to justify the total valuation of financial assets.

    All to say that those graphs have numerators and denominators. The denominator (total assets) can go up and down based on:

    1. The proportion of real assets that have been monetized/capitalized (i.e. students’ future earnings are far more capitalized now than in the past)


    2. The market’s ever-changing estimate of what all those assets are worth — both the capitalized and the uncapitalized part.

    So yes I agree: maybe the decline we see in those graphs is just because so many more assets have been monetized/capitalized over that period.

    I see no research or theory out there along these lines.

    Here’s another graph that relates to this thinking:

    Thinking about the money supply as the sum total of financial assets (all FAs embody money), I’m starting to get all monetarist. Those first two graphs are a straight velocity argument. This one’s a money supply argument…

  • Geoff

    The conclusion appears to be that the recent increases in net worth have gone mainly to those who are less likely to spend it on consumption.

    It is the old “the rich are getting richer” argument. Not sure I buy it but it would explain some things.

  • Tom Brown

    Vincent wrote:

    “The point is the government can always borrow more if the central bank will always make money and buy their debt.”

    While true, that’s not the only way for the government to borrow more. Example: Say the Fed never produces more than $1 of deposits at any one time. Now the Tsy sells 1 trillion $1 bonds over the course of a year, and spends that much as well, $1 at a time. That $1 in Fed deposits will be moved from one deposit to the next and back again (one of the consequences of gov deficit spending) and be used to rack up a gov debt of $1T: but still never more than $1 of Fed deposits existed at any one time.

  • Steve Roth

    Exactly my thinking. Hence the reduced velocity. But it’s not the only possible, or exclusive, explanation. Could have to do with FA values rising because more stuff is financialized/monetized/capitalized.

    But still: some decent evidence that Summers’ secular stagnation is a result of wildly increased concentrations of wealth and income, and declining marginal propensity to spend out of both wealth and and income.

  • Tom Brown

    I think that definition may overlap pretty well with Nick Rowe’s. Rowe definitely thinks that the “most liquid” asset (money) is special, even if other assets exist which are infinitesimally less liquid. He’s actually got a recent post up incorporating the idea of a continuous or near continuous spectrum of liquid assets:

  • Geoff

    I can give you two anecdotal examples that probably don’t mean anything but may still be of interest. My mother and I have both been almost 100% in equities for the past several years, and have both been fortunateto experience a nice increase in our net worths. My mother is retired and lives off her portfolio. Yes, some would say that an old lady shouldn’t be 100% in equities. I manage her portfolio, so sue me. That’s not the point. The point is that her spending has increased along with her net worth, whereasmine has not. I’m still in saving mode. No matter how much my net worth increases, I won’t be increasing my spending any time soon.

  • Tom Brown

    Steve, I read your piece on Asymptosis, and it seemed convincing to me, but I’m not comfortable with my own ability to evaluate it fairly: so I asked for someone else to take a look (someone I was pretty sure wouldn’t agree with you)… they had some complaints, but I don’t know why they didn’t leave their comments directly there or at Angry Bear. Anyway, here’s the critique:

    Any response?

    I feel like I’m a trouble maker trying to stir up trouble… but actually I’m just trying to inform my own opinion a bit more. The whole subject is a bit out of my normal comfort zone.

  • Qcl

    Steve Roth,



    I think you’re confusing different meanings of “reserves”:


    I meant FX reserves of BOJ. I tried to convince Suvy that aggresive accumulation of foreign reserves by BOJ was the reason behind depreciation of Yen, not QE.

    I am not sure if for example German or Spanish bonds count as FX reserves. I think they do.

    What do you think?

  • Tom Brown

    For anybody following Steve Roth’s underconsumption article, here’s some related material, with JKH, Ramanan, Nick Edmonds, and Winterspeak all chiming in:

    My head’s starting to hurt. I think I’ll put that aside for a bit. :(

  • JWG

    In response to Odie’s inquiry way back in the thread, the Federal Reserve Act empowers the Fed to do pretty much whatever it wants, provided it is careful to observe the proper formalities. For example, offshore accounts? They seem to be OK under 12 USC Section 358:

    “Every Federal reserve bank shall have power to establish accounts with other Federal reserve banks for exchange purposes and, with the consent or upon the order and direction of the Board of Governors of the Federal Reserve System and under regulations to be prescribed by said Board, to open and maintain accounts in foreign countries, appoint correspondents, and establish agencies in such countries wheresoever it may be deemed best for the purpose of purchasing, selling, and collecting bills of exchange, and to buy and sell, with or without its indorsement, through such correspondents or agencies, bills of exchange (or acceptances) arising out of actual commercial transactions which have not more than ninety days to run, exclusive of days of grace, and which bear the signature of two or more responsible parties, and, with the consent of the Board of Governors of the Federal Reserve System, to open and maintain banking accounts for such foreign correspondents or agencies, or for foreign banks or bankers, or for foreign states as defined in section 632 of this title. Whenever any such account has been opened or agency or correspondent has been appointed by a Federal reserve bank, with the consent of or under the order and direction of the Board of Governors of the Federal Reserve System, any other Federal reserve bank may, with the consent and approval of the Board of Governors of the Federal Reserve System, be permitted to carry on or conduct, through the Federal reserve bank opening such account or appointing such agency or correspondent, any transaction authorized by this section under rules and regulations to be prescribed by the board.”

    The many different alphapbet soup accommodations to a wide variety of parties during the GFC demonstrated that the Fed will ask for forgiveness later rather than ask for permission first. How about loans to individuals? With the right collateral (perhaps rehypothecated numerous times), no problem.

    “Subject to such limitations, restrictions, and regulations as the Board of Governors of the Federal Reserve System may prescribe, any Federal reserve bank may make advances to any individual, partnership, or corporation on the promissory notes of such individual, partnership, or corporation secured by direct obligations of the United States or by any obligation which is a direct obligation of, or fully guaranteed as to principal and interest by any agency of the United States. Such advances shall be made for periods not exceeding 90 days and shall bear interest at rates fixed from time to time by the Federal reserve bank, subject to the review and determination of the Board of Governors of the Federal Reserve System.” 12 USC Section 347.

    As long as it observes the formalities, and with smart enough lawyers and bankers available, the Fed can pretty much do whatever it wants.

  • Vincent Cate

    The flaw in your argument is not off topic.

  • Vincent Cate

    Your argument is only wrong in the “black swan” even case. The rest of the time what you say is correct. But you ignore the tail event.

  • Vincent Cate

    What do I care if they do $1 trillion all at once or $1 at a time? The end result is the Fed has monetized $1 trillion in bonds with new money, right?

  • Tom Brown

    No, not at all. My point is with the $1 example is that the Fed didn’t “monetize” more than $1 total.

    My overall point was that “monetization” (the way you define it) is not required for the Tsy to do large scale deficit spending. In theory we could reduce that Fed balance sheet down to $0.01 and still deficit spend $1T in a year.

    In practice, the Fed BS only needs to be big enough to facilitate Tsy deficit spending (and of course $1 or $0.01 would both be two small practically, but still, you wouldn’t need a lot!).

    Look at how the “F” variable comes into play on the CB’s balance sheet here:

    It’s independent of “T” (the total Tsy debt).

  • Tom Brown

    BTW, I left a link on your latest post (on your blog) to a Nick Rowe article wherein both he ans Scott Sumner claim that those wanting 0% inflation (or 0% NGDP growth) are “extreme socialists.”

    Ha! … well, perhaps I’m exaggerating a little. Judge for yourself.

  • Steve Roth

    Perhaps, but Nick’s approach is incoherent because it’s defining “monetary assets” relative to “money,” without defining money.

  • Steve Roth

    Yes an apt anecdote but not clear what conclusions to draw from it.

    “a nice increase in our net worths”

    Key issue: are cap gains “income”? They aren’t in the NIPAs of course, but it’s crucial to think clearly about this.

  • Steve Roth

    “I am not sure if for example German or Spanish bonds count as FX reserves. I think they do.

    What do you think?”

    I think you can point to any chunk of the financial assets being held and say “those are the FX reserves.” It’s an accounting designation. (I say: “No, those assets over there are the FX reserves.”) Money (the exchange value embodied in those various assets) is fungible.

  • Qcl

    Thx :)

    I understand that any certain- currency- denominated- asset might be included into FX reserves of this particular currency.

  • Steve Roth

    @Tom Brown:

    Thanks! I had missed that discussion, gosh darn it.

  • unpaid debt screws someone over

    They do know what to buy. They use the dollars to buy real assets – farms, infrastructure, mines. It’s already occurring.

    The fed is buying treasuries. When the taxes are raised and the people who initiated the debt are gone, who’s picking up the bill? The children.

    The national debt is a burden that will ruin our children’s futures.

  • Tom Brown

    Steve, did you see Mark’s comments that I linked to above on themoneyillusion regarding your 1st article?

  • Steve Roth

    @Tom Brown:

    No I hadn’t. Thank you!

    I think my response post went pretty well to the heart of his disagreement:

    “There’s a reason why capital gains are not included in GDP and that’s because it’s *not* income derived from the production of new goods and services.”

    I point out, with two scenarios of a company’s dividend distribution (all or none), why this is not true. The actual transfer of the income is simply deferred in the no-distribution scenario.

  • Johnny Evers

    ‘If I have $10,000 in a CD or in my checking account does not change my net worth and therefore has little bearing on my spending decisions other than liquidity considerations. ‘

    Whoa there.
    Most people if they win a lottery or inherit money immediately spend that money.
    I don’t understand how you say that 10k in deposits wouldn’t change your net worth. I think you can only say that if you are trying to establish ‘money’ as primarily a means of exchange. I prefer to see it as a store of value, even if it’s only temporary. Example: You labor all week and you are given money which allows you to ‘spend’ your labor when you choose.

  • JWG

    Odie, here is Section 13 (3) A of the Federal Reserve Act:

    “Discounts for individuals, partnerships, and corporations

    A. In unusual and exigent circumstances, the Board of Governors of the Federal Reserve System, by the affirmative vote of not less than five members, may authorize any Federal reserve bank, during such periods as the said board may determine, at rates established in accordance with the provisions of section 14, subdivision (d), of this Act, to discount for any participant in any program or facility with broad-based eligibility, notes, drafts, and bills of exchange when such notes, drafts, and bills of exchange are indorsed or otherwise secured to the satisfaction of the Federal Reserve bank: Provided, That before discounting any such note, draft, or bill of exchange, the Federal reserve bank shall obtain evidence that such participant in any program or facility with broad-based eligibility is unable to secure adequate credit accommodations from other banking institutions. All such discounts for any participant in any program or facility with broad-based eligibility shall be subject to such limitations, restrictions, and regulations as the Board of Governors of the Federal Reserve System may prescribe.”

  • Odie


    Maybe you should read my sentence again. I said you have $10,000 in either case. Case 1: It is stored in a certificate of deposit (CD); Case 2: It is in your checking account (or cash). You are now calculating your net worth; would it be any different? However, lots of monetary theory puts an emphasis on “money” versus “bond etc”, while I agree with Cullen here: QE is like converting a CD to a deposit. Net worth is essentially unchanged. Thus, spending remains the same with or without QE. (Neglecting potential effects of QE on interest rates.)

  • Odie

    Not really sure if I agree with your notion that the Fed can just buy whatever it wants. Especially the last cited paragraph clearly lays out that any obligation accepted as collateral must be guaranteed by the US government or subordinate agency. That limits it to treasuries or MBAs from quasi-government agencies such as Freddie Mac. Neither can I see from the citations that the Fed would be allowed to accept stocks etc. It, of course, trades in foreign currencies to support global markets. That is usually the biggest contributor to capital losses due to fluctuating exchange rates.

    The Fed regularly publishes its balance sheet so it is easy to see what assets it holds and which ones it does not.

  • Johnny Evers

    I think the liability is different, though.
    If I have a T-bond, it’s an asset to me and a liability to the general public.
    For a bank, checking and savings have the same liability, right? It’s the inflation liability.
    After QE, I have an asset in the form of a deposit, but the liability (*according to MR*) has disappeared into the Fed’s black hole where we can forget about it). According to conventional economics, that T-bond still exists and still has to be netted out at some point.
    This is an instance in which MR and conventional economics are not having the right discussion.
    Or, which I would prefer — you can call the T-bond a type of hard asset, which an inflation limitation. It’s like gold. Gold is an asset that has hard value; the only risk is that there might all of a sudden be too much gold.

  • Odie

    That sounds like the legal justification for the discount window.
    Here, the Fed loans reserves to banks who are in violation of their reserve requirement and cannot get sufficient funds in the interbankmarket. The eligibility for collateral is rather broad but those assets are collateral, not outright purchases. If the Fed accepts a mortgage loan as a collateral it does NOT buy the house. It expects to get its money back and unless the bank goes bankrupt that is what usually happens.

  • Odie

    T-Bond: Your asset, Treasury’s liability
    Deposit/CD: Your asset, Bank’s liability
    Cash: Your asset, Fed’s liability

    If you do accounting then inflation is not someone’s liability; it is a risk.

    I am not sure if I agree with the notion that the Fed balance sheet is a “black hole”. What it does is taking a T-bill (asset of a bank) and transfers it to the asset side of the Fed. The Fed issues a reserve deposit which becomes an asset for the bank and a liability of the Fed. For the bank it is like switching money from a CD to a deposit on its asset side. The total value of assets stays the same. The Fed has expanded its balance sheet by the T-bill (asset) and the deposit (liability). Once that bond matures the Fed will deduct the funds from the Treasury’s account and destroy the bond. Its balance sheet contracts. So the T-bond is not a hard asset as it matures and vanishes together with the deposit generated when it was issued. Hard assets don’t disappear; they just switch forms.

    You can make a similar claim for gold: The liabilities are the labor and our “debt to mother earth” for extracting the gold. Fortunately, that debt has a very long maturity compared with a human lifetime.

  • Johnny Evers

    ‘Once that bond matures the Fed will deduct the funds from the Treasury’s account and destroy the bond. ‘

    – Where does the Treasury obtain the funds to remit the Fed so the bond can be destroyed?
    – Is it possible the Fed will take back reserves when the bond matures?

  • Odie

    1) It feels like we are going in circles here; please see our previous discussion: If the Fed would stop buying and selling securities, they would all mature over time until it would not hold a single bond anymore. Thus, monetary policy reverses itself. (Of course, our monetary system would have gone bust by then.)

    2) The Treasury has its account at the Fed. Although not a real “reserve account” a debit there will reduce the liability of the Fed. Through the transactions between Treasury, Fed and private banks, reserves get added or subtracted from the system.

  • Johnny Evers

    I think the crux of the confusion is the $1 the Treasury gets when a T-bond is issued. This $1 comes from the bond buyer.
    The Treasury spends that $1.
    So when you tell me the Treasury remits the Fed to destroy the bond, it seems to imply the Treasury gets that $1 back from the taxpayer.

    Another way to ask.
    During deficet spending, an NFA is added — is this permanant? And can this NFA change form — bond to deposit — if the Fed chooses?
    Does QE destroy the bond?

  • Odie

    Indeed it gets it back; either by taxing (balanced budget) or by issuing a new bond (further deficit). Correspondingly, the monetary net worth of the private sector will stay the same or increase by $1 while the Treasury assumes another $1 in liabilities (debt). All monetary balances will add up to zero. (That the private sector has $1 M at the beginning is a sleigh of hand on my part. Someone will hold the corresponding liability.)

    “During deficet spending, an NFA is added — is this permanant?”

    If the gov runs a balanced budget from then on, yes. With a surplus, no. With further deficits it will increase.

    “And can this NFA change form — bond to deposit — if the Fed chooses?”

    Yes, but the deposit will be in a reserve account of a bank. You won’t really sell to the Fed.

    “Does QE destroy the bond?”
    No, it passes ownership: From a bank to the Fed. The bond disappears at maturity or when the Treasury buys it back from the Fed. (Like you paying off your mortgage early.)

  • Johnny Evers

    Indeed it gets it back; either by taxing (balanced budget) or by issuing a new bond (further deficit).
    – A balanced budget would merely pay existing bills. You would need a tax surplus to redeem bonds.
    And if you issue a new bond then you are crowding out borrowing for ongoing needs. Let’s say you sell me a bond — I get the bond, but my deposit is used to destroy the bond.
    So now we’re getting into issueing bonds that don’t provide any future good. We’re borrowing for past spending.
    What you are saying is that the T-bond eventually has to be ‘paid back’ (either by tax receipts or new borrowing, which is pretty traditional thinking, and unlike MR which says that bond is an asset unto itself and can sit on the Fed’s balance sheet forever, or just disappear in there.

  • Odie

    “– A balanced budget would merely pay existing bills. You would need a tax surplus to redeem bonds.”

    That’s right. With a balanced budget the value of outstanding bonds stays the same so if one matures the Treasury has to issue a new one (roll-over). Even during the Clinton surplus years the Treasury kept issuing new bonds because the old ones were maturing.

    “And if you issue a new bond then you are crowding out borrowing for ongoing needs.
    Let’s say you sell me a bond — I get the bond, but my deposit is used to destroy the bond.”

    You mean like the Treasury taxing you out of the deposit and then destroying the bond? Sucks for you, so the government keeps borrowing that you can enjoy higher monetary net worth.

    “So now we’re getting into issueing bonds that don’t provide any future good. We’re borrowing for past spending.”

    Nope, in a balanced budget you can keep your savings. Does that not provide a future good?

    “What you are saying is that the T-bond eventually has to be ‘paid back’ (either by tax receipts or new borrowing, which is pretty traditional thinking, and unlike MR which says that bond is an asset unto itself and can sit on the Fed’s balance sheet forever, or just disappear in there.”

    An individual bond has to be paid back. But the Treasury can just roll it over, therefore debt stays the same but ownership of the bond may change. The bond is an asset on the Fed balance sheet but it will not “disappear” there. Banks (including the Fed) are run by accountants; nothing just disappears.

    I don’t think it is too difficult to add those points in the “balance sheet” I made:
    Simplified (only assets; T-bond of $1 million):
    1) Start: You: $1 M; Tsy: 0; Fed: 0
    2) Buy bond: You: Bond; Tsy: $1 M; Fed: 0
    3) QE: You: $1 M; Tsy: $1 M; Fed: Bond
    4) Tsy spending: You: $2 M; Tsy: $0 M; Fed: Bond
    5a) Tsy taxes: You: $1 Tsy: $1 M Fed: bond
    6a) Maturity: You: $1 M; Tsy: 0; Fed: 0

    or 5b) Tsy rolls over: You: $1 M + bond; Tsy: $1 M (- bond); Fed: $1 M
    6b) You: $1 M + bond; Tsy: (-bond); Fed: 0

    In 6a your net worth is $1 M, in 6b $1 M + bond. What would you prefer?

  • Johnny Evers

    I would rather you have $1 rather than a $1 bond.
    The bond is a future liability to me. Either my taxes will pay down the bond, or I will buy a future bond — with the proceeds going to you.
    Borrowing for ongoing or current spending makes sense. And creates an NFA. Borrowing to pay back somebody for a past loan is not stimulative in any way.

  • SS

    You need to read more of Cullen’s work. Government debt doesn’t get paid back. It pretty much always grows. Same for private debt.

  • Steve Roth


    Right. Here are some graphs that zoom in on successive periods, with commentary. Also for the UK:


    This is nominal debt, of course. Debt/GDP measures (for example) raise different issues.

  • Cullen Roche

    Yeah, I talked about this in my recent interview. It’s a fallacy of composition to assume that aggregate debts must always be paid back just because individuals must pay back their debts. The govt is just an aggregate entity because it accumulates revenues and spends to so many. But don’t get me wrong. This doesn’t mean debt is always good or that debt can’t be paid down for brief periods. It just means that over the long-term it’s highly unlikely that aggregate debts will be paid back. And in fact, I’d argue that it would be problematic if they were.

  • Suvy

    There was no increase in the amount of FX reserves held by the BOJ since 2012.

    By the way, did anyone see the current account balance on Japan today? Yen dropped over 1% today so far. The reason why the Yen is deteriorating is fundamental. As the Yen worsens, I expect the current account balance of the Yen to continue its deterioration since Japan imports most of its food and all of its energy.

  • Suvy

    You also said that low interest rates support the value of the currency and used the UIP to support that hypothesis, but UIP doesn’t hold. I even cited a recent AEJ paper too.

  • Johnny Evers

    It’s very comforting to believe that debt — federal and private — will always rise, no problem … without also setting forth the limits to which debt can rise.
    Just as an obvious example, without growth, debt will eventually drown the system.
    Also, historically speaking, debt is always being destroyed.
    In the U.S., for example, the federal debts accumulated in the Civil War, were paid down during the rest of the century, when growth was very high.
    And Confederate debt became worthless.
    People who manage money tend to look at debt as an asset, so our world view gets altered. Debt is good, because it’s money that somebody else owes to us, and they pay us interest. It might not represent real production or value anymore, but we still insist that it must be protected so our interest stream can continue.
    If you look at the other side of the equation, the person or institution in debt has a different outlook.

  • Gary Miles

    Hi Cullen, I always find your ideas thought provoking but I am trying to unravel some biases about money printing. Correct me if I am wrong but the Fed buys Treasury Bonds from the Treasury Department to maintain interest rates at desired levels. In order for books to balance the Fed has to pay for these Treasury Bonds with something. My information, thus far, is that the Fed’s computer credits the Treasury Department’s computer to make the accounting work. Treasury Bonds are the stuff that makes up the “World’s Reserve Currency”. When the Fed manufactures the payment for the Treasury Bonds “out of thin air” are they not engaging in a form of money printing? Do these additional units of “Currency” dilute the value of the existing Treasury Bonds held by China and Russia, in a significant way. Thanks, Gary Miles