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.

More Posts - Website

Follow Me:


  1. “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, 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.

      • 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.

        • 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.

          • 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.

            • 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.

              • 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.

                • 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.

                  • 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.

                  • 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.

                    • 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,”

                    • 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

                    • 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.

                    • 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.

                  • 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…

                    • 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.

      • 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).

        • 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.

          • 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.

  2. 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.

      • 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.

        • “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.

          • 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.

          • 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.

    • 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.

      • 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.

        • 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.

          • 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”?

            • 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.

              • 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%

                • 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.

  3. 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).

  4. 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.

  5. 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.


  6. 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.

  7. 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?

  8. 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.

    • 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.

      • 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.

        • 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)

      • 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.

        • 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.

          • 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.

  9. Cullen,


    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?

  10. 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.

    • 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…)

    • 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.

      • “”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?

      • 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…

        • 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.

          • “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.

            • 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.

    • 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.

      • “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…?

      • @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.

        • 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).

        • 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.

          • “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…

          • 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.)


          • “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.

          • 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.

            • 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.

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

              • 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….

                • 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…

                  • @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.

                • 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.

                  • 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.

                    • 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.

                    • 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.

                    • 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.

          • ‘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.

            • Johnny,

              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.)

              • OK.
                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.

                • 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.

                  • ‘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?

                    • 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.

                    • 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?

                    • 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.)

                    • 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.

                    • “– 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?

                    • 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.

                    • 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.

                    • 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.

  11. Cullen,

    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.

    • 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.

      • 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.

  12. “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.

    • 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.

      • 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!

        • 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.

          • Vincent,

            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.

          • 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.

            • 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?

              • 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).

              • 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.

      • 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….

        • 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).

          • 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).

              • 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.

  13. 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?

    • “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.

      • Thx :)

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

    • 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.

  14. 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.

    • 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.