Burn This Into Your Brain….

I really like this quote from the NY Fed:

“Most commonly used measures of the broad money supply include both currency and certain types of bank deposits, which in effect represent money created by banks when they make loans, but not reserves. These broad money measures tend to be more directly relevant for economic activity and inflation.” (emphasis added)

Almost everything we’ve all learned about money and economics is built around the government or its agents (primarily the Fed).  We are all taught through popular mythology that the government has a “printing press”, that the Fed creates all the money or that the government creates all the money.  Most economic models are designed around this thinking.  Monetarists build their theories around the idea that the Fed controls the money supply. Keynesians say the government can control the money supply through various countercyclical policies.  The quantity theory of money still dominates economic models.  And the money multiplier runs rampant implying some direct connection between banks and the government.  In essence, we always come back to one form of money that supposedly “rules the monetary roost” – high powered money or what MR would call “outside money” – money created by the government outside the private sector.

We’ve all been led to believe that this is the form of money that matters most because it is the form of money that is used in policy to steer the economy in some way.  This ties nicely into my recent commentary on economic ideology and how policy perversion results in policymakers and economists assuming that they can steer the economy and the money supply through their various “solutions” to problems.  The only problem is that this is all entirely backwards.

As the NY Fed states, the money that matters most does not come from outside the private sector.  It comes from inside the private sector.  Banks rule the monetary roost.  Government money is nothing but a facilitating feature.  It is a support structure designed to influence and support the use of bank issued money. We’ve all been lied to.

See the MR primer here for the way the system and its institutions are actually designed….


Got a comment or question about this post? Feel free to use the Ask Cullen section, leave a comment in the forum or send me a message on Twitter.

Cullen Roche

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

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  1. Perhaps We need a 3rd form of money. Call it “Middle Money”.
    Middle Money could be used by individual citizens to help facilitate the easing of financial hardships brought on by a debt laden balance sheet of inside money.
    The private citizens need a vehicle to off load or swap their toxic debt of inside money so they can continue to get financially healthy.

  2. Cullen what money supply measure do you prefer M2 or M3 (from your friend at shadowstats), Adjusted Monetary Base, Austrian money supply, total credit or something else?

    I see many gold bugs looking at M2 or other measures as a precursor to hyper/high inflation. But I don’t see any value in paying attention to money supply as its correlation to cpi, gdp etc is dubious. Is tracking money supply under a fiat system of any importance?

  3. Bank deposit liabilities increased when the non-banks sold t-bonds to the Fed. Why the big fuss over that ZH chart?

    And none of this is theory….

  4. Cullen,
    Banking rules the roost when it comes to business and household credit and spending and investment. Real resources and real inventories and real output can be collateral for an increase in bank supplied inside money. But dollars are drained from the economy by imports and savings. There has to be a balancing act of private credit and public deficit spending to make up for those dollars being drained or the economy cannot grow.
    So the true source of money has to come from the sovereign government. I don’t think there is any disagreement. I think you are just placing a higher priority on private money when it comes to how the wheels turn in our real world economy. Correct?

  5. As loans create deposits, does it follow that total deposits are equal to total loans?
    Would that mean that every dollar on deposit represents a dollar that is owed to somebody else?
    Is there a way to add money to the supply without creating a loan?

  6. It would be nice to have a handy animation along the lines of the following:


    to explain exactly what’s going on w/ some of this stuff that’s a little more complex (like the banks acting as intermediaries to “on-sell” treasury securities to the Fed from non-bank sellers). Could save you a lot of keystrokes! ;^)

    I could see the balance sheet slowly changing… as we move along the ZH curve, etc. Hell if I was a better programmer, I’d volunteer to make one for you (but I mostly program FPGAs, so I’m not up on all that fancy interactive stuff).

    I wish the folks on that site would hurry up and get the “capital requirements” animation finished… I’m looking forward to seeing that one.

  7. US Government spending more than it taxes adds dollars, which show up in bank deposits. All those extra dollars make up the national debt in Treasury securities. But the inside dollars and the outside dollars are all mixed up together. They just all add up in the GDP numbers.

  8. Why does that chart concern endogenous money creation? Deposits are bank liabilities. WFC has been adjusting their liability structure to protect their net interest margins. Meanwhile, credit demand is still fairly low. Ergo, deposits rose faster than loans.

  9. The way I like to phrase this is that the money system is built around bank money. That is, cash supports bank money by allowing its users (who have bank accounts) to draw down an account for convenience in transactions. Reserves simply support the banking system by helping bank settle payments smoothly (in addition to monetary policy, which is slightly different). But the problem is that this money system designed on inside money is inherently unstable because the private profit based system of capitalism is inherently unstable. The govt can support balance sheets through the issuance of NFA like bonds, but don’t confuse this for money issuance. The govt is a redistributor of bank money. It is not an issuer of money (though it could choose to be). It is a facilitating feature to a system designed around private issuance of money controlled by an oligopoly who compete for the demand of money by debtors.

  10. Not necessarily. See the ZH chart that everyone keeps floating around. But it doesn’t change much. Deposits are liabilities of banks no matter how they’re issued.

  11. Interesting.
    What makes it a tricky concept is that while I see that loans create money, they also create an obligation.
    For example in the interactive presentation, if I borrow money, it increases my deposits, but it doesn’t do anything for my net worth. And in fact, paying interest on my loan reduces my net worth. The only way for me to improve my Net Worth is to default on the loan.
    Doesn’t that tell us that they best way to deleverage the consumer is to discharge his debt, because he no longer has the money to repay the loan?

  12. No, this is important. US govt spending more than it taxes adds NFA, not dollars. When the govt deficit spends it sells a bond to Peter who is issued a NFA as a bond. The govt obtains credits to its account which it then redistributes to Paul. So the flow of funds is quite simple. It’s inside money in, inside money out, NFA out. Bonds are securities. Not money.

  13. Ah, I’ll take a crack at this.

    Deposits always equal to loans? No. For example, a transfer deposit (somebody who moves their money from one bank to another) results in reserve bank-assets (rather than loan bank assets) going up simultaneously with deposit bank-liabilities at the receiving bank. Also there’s the intermediary function that Cullen referred to: it seems that banks can not only sell their own treasuries to the Fed, but they can act as an intermediary to let non-bank’s sell their treasuries to the Fed. This results again in bank reserve deposits (assets) growing simultaneously with their deposit liabilities. (I think that’s strictly true for the banking system as a whole… as the treasury seller may want to deposit the proceeds from his treasury sail in a different bank… but I’m not sure about that).

    Every dollar on deposit = a dollar owed to somebody else: I’m going to punt on that one. I would say “NO” because of my transfer deposit example. Sure the bank then OWES the depositor that money (which is why it’s a “liability” on the banks balance sheet)… but the bank simultaneously gets reserves (in the form of vault cash or electronically) to match that liability, so it’s a little murky. Plus in some big picture sense (that I’m missing) perhaps the answer is a little more nuanced.

    Any way to add money to the supply w/o creating loans: Sure.. $1T coin is an example. I think that’s also strictly what happens when the Fed does QE purchases of treasuries from banks or non-banks: treasuries (not money in a narrow sense) are swapped for reserves (base money). That money essentially was created by the Fed. Net financial assets in the economy did not change, however.

    OK, pile on. Where did I go wrong?

  14. Cowpoke … Boom, I noticed the exact same thing.
    Also, if the household makes loans and pays interest, over time his Net Worth declines and the Bank’s Net Worth increases. And the banks inevitably wind up with all the money to nobody to make loans to, so they must try to speculate on their own to keep increasing their net worth. Hence, they are not even in the loans business anymore!

  15. Well yes, that’s one way! ;^) … cash advance on all your credit cards and then stop making any payments. In a month or two you’ll get another credit card application in the mail (I actually heard of that happening in the early 90s… although I doubt it would happen today).

  16. … well, perhaps it was a business loan and you were able to use it to help bring in additional income and repay the loan with interest and improve your net worth, all at the same time.

    Regarding discharging the consumers’ debt. Well we do have bankruptcy (still — despite the 2005 law re-writing the rules in the banks’ favor)! That’s one way to get out of it. I have the impression though that creditors are trying to use political influence (the world over) to eliminate as many risks as they can from making loans (loans, ironically, for money they didn’t have in the first place… it’s just that they had a government charter to create a loan/deposit, and somebody else didn’t). I don’t think that’s healthy. Making a loan is inherently risky… if you extended credit to Greece and they can’t pay, does that mean you should be allowed to claim your chunk of the Parthenon… or should it mean simply that you lost on that gamble? I think it should be the latter… but then again, I haven’t made anybody a multi-billion dollar loans to dead-beats!

  17. But when a bond matures, it becomes cash. And those dollars can be spent or deposited. NFA becomes dollars. No?

  18. Government bonds don’t mature. They get rolled over. But yes, if the government allowed all of its debt to mature and didn’t roll it over they would issue deposits in place of the bonds. But that’s not what actually happens. Cullen, correct me if I am wrong.

  19. LVG, no need to antagonize. It’s not surprising that the coin idea got shot down. I didn’t think a politician would actually use it. But I am surprised that they didn’t use it as leverage to try to close the debt ceiling….

  20. That is a point of contention.
    In my view, a treasury = a dollar, if no other reason that it can always be redeemed for a dollar in the open market. And the day it cannot be redeemed in the open market is the day the Fed redeems it for you. If it quacks like a duck, etc.
    So maybe it’s also accurate to say that deficit spending creates a dollar spent into the economy by swapping one type of net financial asset (savings) for another net financial asset (a treasury.)

  21. If you think a US Tsy bond is the same as a bank desposit then have the Tsy issue you the bond in physical form and walk it into Wal-Mart and buy something. They’ll tell you to screw off. Now, what you could do is find someone else inside the Wal-Mart to sell the bond to. But that would be a transfer of money for bonds. See how that works? The the bond seller has the same problem you did….You both DO NOT have money.

  22. not only dubious in many case there are periods of **negative** correlation between M2 growth and cpi.

  23. If I tell them I have $100k in cash held at Main Street bank, they’ll tell me to get lost, also.
    They will want me to convert that NFA into something they can take.
    If I tell them I have 100k in Treasuries at my brokerage, will they give me a Wal-mart credit card? You bet!

  24. Cullen, are you sure about “inside money in, inside money out” to fund federal deficits? Take the fiscal year 2003 as an example, when the federal deficit was $374 billion (http://www.cbsnews.com/2100-250_162-570166.html).

    According to the NY Fed (http://www.newyorkfed.org/research/current_issues/ci11-2/ci11-2.html), for the calendar year 2003:

    “The Treasury auctions an astonishing quantity of securities. In calendar year 2003, it auctioned $3.42 trillion of securities, including $2.78 trillion face amount of bills, $616 billion principal amount of notes, and $26 billion indexed principal amount of TIPS, in a total of 202 auctions. Most of the auction proceeds went to redeem maturing issues ($2.83 trillion) or to bridge short-term gaps between expenditures and receipts ($229 billion), but $363 billion was new money.”

    So the federal deficit was $374 billion and primary dealers created $363 billion in new money during the auction process. In other words, the government is creating NFA while the banks create deposits. This is just ordinary bank balance sheet expansion like any other bank loan. US fiscal policy uses bank printing presses to expand the money supply. So there is no “inside money in”, there is only “inside money out”.

  25. Not many people thought that FDR would confiscate gold nor that Nixon would take the dollar off the gold standard. I have no idea the state of the coin but stranger back room deals often happen with currency.

  26. I am positive. I’ve talked to people high up in the NY Fed’s capital markets group about this. I’ll post the Fed source quote again.

    “The primary way dealers finance their bond purchases is in the repo market. So here is one scenario. Funds are wired from the dealer’s account at its clearing bank to Treasury on issuance day. During the day, the clearing bank provides intraday credit to the dealer, so the dealer is borrowing from the bank. That same day, the dealer enters into a repo, pledging the newly acquired Treasury as collateral. The other side of the repo is likely to be a money market mutual fund or other money market investor. Therefore, by the end of the day, and for the overnight period, the money market investor is effectively funding the dealer’s position. Of course, there are a variety of ways in which positions can be funded, but the repo market is the key one.”

    Again, this is straight from someone in their capital markets group. It’s inside money in, inside money out PLUS NFA as bond.

  27. They will take a Check, Nothing stopping them from taking a Tsy bond.
    What’s the difference, they are both a demand instrument aren’t they?

  28. A check is a promise to deliver bank deposits….When you write a check you are promising someone else bank deposits. When they deposit the check your bank account gets debited and theirs gets credited. It’s very different from a securities sale.

  29. The usual claptrap. Anyone who has knowledge about bookkeeping knows how money/credit/debt is created.

  30. But the bond has value. Your checks have no value. They only represent the (potential) value in your bank account. It’s kind of like a credit card. Your credit card is not money. It is a promise to deliver money.

  31. Interesting. So do you have any idea what the NY Fed is referring to when it says “$363 billion was new money” in the link I posted? That’s very confusing to me.

  32. OK, look at this:

    Now see this:

    “How do I begin using Direct Deposit?

    The process is easy! There are two ways to enroll—one for federal government benefits only, and a second for paychecks, federal & state government benefits, and other sources of income.”

    So the US Govt issues a TSY and then Gets Cash to load a Walmart Card OR A Pay Check.

    Looks to me like a TSY can be used Defacto at Walmart unless I am missing something here.

  33. I can’t be positive, but even if it is new money it’s money being created by the PD’s bank unit which just means it’s inside money being redistributed. But as my Fed source said, the intra-day loan from the PD’s bank unit is unwound by end of day.

  34. You can solve that pretty easily. Ask the US Tsy to send you a t-bond in paper form. And get in the checkout line at Wal-Mart. If it’s as good as cash (like asking your bank for your bank deposits in physical form) then you’re right….But 99% of retailers will tell you to screw off….

  35. I didn’t know that. Well, they’re still out there floating around. Maybe you can get your hands on some. It would be fun to walk around all day with an ounce of gold and a US T-bond and see which stores, if any, would accept them. That’s the ultimate in paper bug vs gold bug battles. :-)

  36. Hey, that tool I was talking about that would animate a bank selling treasuries (QE) vs a non-bank selling treasuries (also QE), and the effects on … well pretty much everything, is already there:


    … plus it can do a LOT of other transactions too.

    Play around w/ the controls at the bottom. It illustrates pretty well what Cullen was talking about. The only word of caution is that I noticed that:

    1) The Treasury balance sheet and the Federal Reserve balance sheet in the lower left corner are both categorized as “Federal Government” which is not in agreement with MR.

    2) The reason for 1) above is because I think the website is associated with MMT rather than MR. But I didn’t see anything on the interactive animation that was inconsistent with MR other than 1). But I didn’t examine every detail.

    Overall, it looks pretty useful! Kafkaesque is the one who originally posted the link to the above page here a few days ago… I thought it looked too complicated at first, so I gravitated to the simpler page I posted above, but it’s actually pretty good I think! Check it out and see what you think.

  37. If you look at a chart of the money supply during a recession, it doesn’t fall with private sector credit. It seems like there has to be new money credited to some other entity for this to be possible. And we all know government deficits automatically increase in recessions as tax receipts decline. I struggle understanding how the money supply can avoid following private sector credit unless new money is created to fund government deficits. I don’t know the answer. I can’t fully explain this process, but the “inside money in, inside money out” explanation doesn’t satisfy me either. I appreciate your comments – very interesting debate.

  38. The money supply measures contain a lot more than private credit….Plus, this explanation doesn’t come from me. It comes from someone who works on the NY Fed’s Capital Markets Group. The process make total sense. Think of it like Tsy Direct. It’s the same thing basically that the NY Fed source explained.

  39. In case you’re wondering, in order the get the “QE (Variation 2: bank sells)” operation to work (e.g. after a reset) you have to first get some treasuries into the bank’s assets.. one way to do that is the operation right under the QE ones called “open market ops: raise rates towards target.”

  40. The operation would be simple. It would be a combo of bank loan + tsy sells bonds. It’s tricky though because you’d have to include the intra-day loan and repo in separate transactions. It’s easier to explain it via the flow of funds than it is to build into a model like that.

  41. That sounds like a challenge! One that … uh, I’m not willing to take you up on. Anybody else? ;^)

  42. A well known method to get engineers to spend countless hours of unpaid overtime working on a hard problem is to casually say something like this to them: “X can’t be done. It’s no use trying.”

    Using a similar method, I quoted what you just wrote on their comments section, saying “so what of it guys, can your visualizer be made to visualize that or not?” (I didn’t mention who you were). So we’ll see what comes of it! Hahaha

  43. I don’t know. Good question. So grandpa dies, he left you a dollar in his will, and he had a debt of $1 to the bank. What happens?

  44. MMT = gets state money right, but pays way too little attention to private credit money ( they say that’s not true, but it took them forever to “get” Keen bc they didn’t understand his MCT approach).

    Full Reserve advocates = get that private money creation can be a big problem; generally don’t know enough about economics to convince anyone that a true “state money system” (not the chartalist version which accepts private money even if not focusing on it) would be better.

    MCT circuit theory/horizontalists= get private money creation right, but don’t integrate it with state money enough, and not always critical enough of private credit money’s dangerous effects; & they would be out of a job if we had a true state system of money, which may make them not exactly in love with the idea.

    Put the best of these three together and we would have a workable, fair, stable system of state money (what I would call “true chartalism”). Although MCT’ers would be out of jobs as there would not be private credit-money creation, as I said.

    MMT’ers should want this but are too tied up in Knapp to know it.

    Full Reservers should want this too but (most of them) don’t realize reserves or loanable funds have nothing to do with private money creation, and that they are actually longing for a pure state money system without knowing it because (most of them) don’t know enough about the monetary system.

  45. A Treasury and a dollar are both backed the full faith and credit of the U.S. government.
    Not sure why you would limit the definiation of money to something a retailer will take. Most retail transactions are in the form of a promise to pay. Is the promise the money? Other retailers might only accept cash. Some don’t accept physical cash at all.
    I think it’s best to look at what a dollar bill and a Treasury have in common — the principal is guaranteed by Uncle Sam. The dollar bill is merely a 0 percent interest bond.
    If you accept that idea, does it complicate the understanding of MR in some way? I thought it would be a useful concept in helping people understand that we are not borrowing money, we are creating money.

  46. Well, it’s called Monetary Realism. So, if I started calling bonds “money” I wouldn’t be telling people the “real” part of the Realism. Bonds are securities. They are deferred spending that equate to a claim on money. Fannie and Freddie are backed by the “full faith and credit” of the USA. Should we start saying that everything they issue is “money”? Obviously not. This is about getting the meaning of words right and staying consistent with definitions so we don’t contradict our understandings of the system. That’s all. Nothing more.

  47. If I walked into a Walmart with GBP or JPY and tried to buy something they probably wouldn’t accept those either. Are Pounds or Yen money?

  48. So there are forms of money that are not accepted by US retailers. Ergo the fact that retailers wont accept something as a means of payment does not mean that it is not money.

  49. If someone doesn’t accept a form of payment it’s because they don’t consider it money to them. As Minsky said, the problem of money is not defining what it is, but getting others to accept it. In the case of Wal-Mart, they will NEVER accept EUR or US T-bonds because it’s not money to them. That doesn’t mean it’s not money to other people or other businesses. If you can’t use something for purchasing goods and services in a country then its moneyness is not very high. In the USA, the things with the very highest level of moneyness are cash, coins and bank deposits. Primarily bank deposits….Not sure why that’s controversial.

  50. Keen always warns about (levels of) private debt and if the monetary system were to change I don’t think it would put him out of business because the other aspect of his research is dynamic modelling (who would have though that time was an economic variable!!) — which will always be needed regardless of what system is being used.

  51. I would say that a Treasury is accepted as money everywhere on earth, so that would satisfy Minksy.
    We are moving toward a cash-less society, in which most bank deposits are held as Treasury or similar instruments. Even people who say they hold ‘cash’ really are holding short-term Treasuries.

  52. There is no private creation of money with full reserves. Bank credit = debt = money as a system goes away. It takes double thinking anyway to consider bank credit as money, especially when the unit itself returns to the ledger and disappears. Full reserves uses money, not bank credit. Money stays in the supply and mediates transactions over and over. Money has no associated liability, so it doesn’t want to disappear. It simply is, and stays in the supply unless it is hoarded. Or, government can tax the money supply and not recycle (ot likely).

    The usury is the real problem. If real money is used, then its volume matches goods and services. Usury on the system then demands exponential growth on a money supply that should be fixed. This is another double think that confuses the minds of men. Therefore, any real money system should not have usury, and the only system that does this is demurrage. State banks that are 100 percent reserve could redistribute usury by offsetting taxes. State banks that issue credit (bank money double think using hypothecation) could do banker tricks and forgive loans, thus allowing the liability association with credit to disappear, hence turning credit into money.

    Davis mutual credit is another system, really a form of greenbacks, which are spent into households as seigniorage. This puts the money power into the base of the population, where it belongs. There is also mutual credit systems, where a credit and debts counter each other without usury.

  53. I was just reading the 10-k of a random bank and it described its business in this way which struck me as interesting:

    “The principal business of the Bank has historically consisted of attracting retail deposits from the general public and investing those funds primarily in one- to four-family residential mortgage loans, commercial and multi-family real estate, agricultural operations and real estate, construction, and consumer and commercial operating loans primarily in the Bank’s market areas.”

    Given that the company emphasizes “attracting” deposits and “investing” them rather than creating them through loan generation, do get the sense that this company doesn’t understand its own business model?

  54. Among other errors, the attached paper says selling treasury bonds has nothing to do with funding the govt?Didn’t England invent selling govt bonds to the local rich to fund the military and become dominant over France who did not sell bonds? This was centuries ago. It is not ‘self evident’ or well argued that going off the gold standard stops this basic funding tradition.

  55. I understand the Fed means the money created by the repo transaction. Repo is a short term loan that creates this inside money – the parties just not being part of the banking system but what they call ‘shadow banking system’.

  56. MR (and MMT?) are the only economic theories that seem to deny the basic definition of money – a medium of exchange.

    If one wanted to spend $10k+ at Wally World, I suspect the manager or the next level up would gladly accept a Treasury.
    I’ve bought many not inexpensive things over the decades at various stores with gold too.

  57. What in the world are you talking about? I always say the primary function of money is as a medium of exchange. The problem with gold and t-bonds is that they’re not very widely accepted. This renders their moneyness much lower than something like bank deposits.

  58. What do you mean? They won’t take a check or credit cards? If they only accept cash, then keep in mind that cash is considered to be “bank reserves” until the moment a bank customer walks out the door (or away from the ATM) with it.

  59. Lots of “money” items aren’t widely accepted, but they’re still money. It’s not complex – if it’s used as a medium of exchange, it’s money. Stocks aren’t usually money, but when they’re used in a corporate buyout, they are money.

    Sorry, thought that MR didn’t use that definition since I’d never seen it specifically mentioned.

  60. Yes, but reserves (bank assets), in the amount of your payment, are transferred from the buyer’s bank to the seller’s bank to back the change in deposits (bank liabilities: from buyer’s bank to seller’s bank) associated with a check or credit card payment. That’s really the only form of “money” that’s transferred in those cases (unless the buyer decides to cash the check rather than deposit it… in which case an additional transaction is processed in the form of a disbursement of bank reserves (vault cash) to the seller).

  61. Of course the PDs have to purchase the Treasuries before they can sell them to the Fed (or whomever). But the Fed (or whomever) pays for them and that cancels the temp repo purchase loan.

    It’s a wash at the PDs. They’re nothing more than an intermediary between the Treasury and the Fed. As CR said – “the intra-day loan from the PD’s bank unit is unwound by end of day.”

  62. That ZH chart is possibly bogus, but I’m not certain.

    I could not find the deposit figures anywhere in H8 that matched the chart. Loans, yes – deposits, no.

  63. They key is *transferred*, as in changed or as in accounting 101.

    Bank reserves just plain aren’t the same as checks or credit cards. There are accounting steps that take place between the two.

    Besides, I was just giving CR a tough time with the odd way that MR treats bonds or stocks or gold when they’re actually used as money (medium of exchange definition).

    When an old Roman denarius is used as money (medium of exchange) today between two participants, it’s money even though it’s far from widely accepted.

    When a denarius is being bought by a coin collector, something else is usually being used as money, like a check or credit card.

  64. I agree that bank reserves are not the same as a credit card or a check, but they are a key component of using either of those methods of payment. Also, my statement that the reserves are “really the only form of “money” that’s transferred” is incorrect, since the customers’ deposit accounts were also adjusted.

    Since you seem to be an expert on “accounting 101″ here’s a question for you: Say the bank itself (Bank A) is the customer of Wally World: it purchases tickets for its employees say, as a “thank you” for hard work. I’m going to go out on a limb and assume Wally World holds a deposit account at another bank (Bank B), and that WW accepts checks and credit cards for payment.

    What do bank A and B’s balance sheets look like after the payment clears? (Assume that both banks start out with plenty of excess reserves, and that it’s been a slow week, and that was the only transaction either bank engaged in). Would Bank A’s reserve account decrease by the amount of the tickets while Bank B’s reserve account increase (along with its Wally World deposit account liability) by the same amount? I’m asking because I genuinely want to know.

  65. How about this. We need to get everyone out of the mindset of talking about the Government. We need to get people into the mindset of taking their future in their own hands and letting capitalism prevail.
    Maybe what we need is an America and a West America for the people who are doers and leave those that don’t in another country.

  66. But doesn’t treasuries bought by the PD’s/Foreign Govts increase our money supply just like a private sector loan? In that case, when bank credit is lacking, can’t the Govt through fiscal policy jack a ton of money in to the economy without people having to take on debt? When I see $5 trillion in debt owned by the Foreigners, $2 trillion by the Fed, and whatever the PD’s own. That is a significant number of private sector assets with out liabilities… aka savings?

  67. “Most commonly used measures of the broad money supply include both currency and certain types of bank deposits, which in effect represent money created by banks when they make loans, BUT NOT RESERVES. These broad money measures tend to be more directly relevant for economic activity and inflation.”

    That quote from the NY Fed that Cullen “really like[d]” is wrong. Money stocks M1 and M2 do include bank reserves. That’s why, owing to QE, M1 and M2 are increasing at a tremendous rate. Here’s a direct quote of Cullen’s on 01/08/2013 supporting that view:

    “M1 is the monetary base. So, an increase in reserves causes this to shoot up.”

    And M2 includes M1, so M2 also includes bank reserves.

  68. I didn’t say anything about m1 & m2 in this post. Anyone familiar with my work knows I differentiate between inside and outside money….

  69. The NY Fed wasn’t speaking of M1 and M2 as the “most commonly used measures of the broad money supply”? What money stocks were they speaking of?

  70. How about when a bank writes a check… say to pay its electric bill? What account of the bank is debited? Is it the bank’s “reserve deposit” at the Fed?

  71. Yes, but during this process the nonbank public ends up with an increase in deposits. And don’t the PD’s simply transfer reserves over to the Treasury’s account when they purchase treasuries?

  72. Just because the money supply has increased doesn’t necessarily mean that net worth, or spending power, has increased. Nor does it mean that there is an inflationary power keg ready to be lit.

  73. But it also can mean net worth increased and spending power increased. Because during that time you had an economic stimulus which gave real income to real individuals. The fact the M2 money supply increased during that stimulus and the Fed QE2 purchases is mighty suspicious!!

  74. Paul, then how do you explain this Cullen quote on 01/08/2013:

    “M1 is the monetary base. So, an increase in reserves causes this to shoot up.”

    I’m not trying to catch anyone in a mistake. I’m trying to understand Monetary Realism.

  75. Hi Mark,

    That’s a brain fart on my end. M1 is notes, coins and demand deposits. MB is notes, coins and reserves. Sorry for the confusion.

  76. So, with that little detour out of the way, back to my original question: Why are M1 and M2 increasing extremely rapidly? The start of the rapid increase of M1 and M2 coincided with the launch of QE. According to Monetary Realism, QE increases reserves (outside money), yet M1 and M2 (inside money) are skyrocketing.

  77. When a non-bank sells a bond via QE they are credited with deposits. So M1 rises as a result. I haven’t looked at the components, but that’s my guess here.

  78. Cullen wrote: “When a non-bank sells a bond via QE they are credited with deposits.”

    So the government (i.e., the Fed) is creating inside money in the form of bank deposits. And apparently, if you look at a graph of M1 or M2, it is creating quite a lot of inside money. This undercuts to some degree at least the core principle of MR that the private sector rules over the inside money supply.

  79. I agree, I was always under the impression that there was two ways to inject money in to the private sector and the way via the Govt was our “net savings” since private loan creation is a wash. Looking at the M1/M2 graphs it definitely correlates to the Fed QE purchases, whether that’s them buying from the PD’s (which I thought is all they do) or them buying from the nonbank public. I’ve been under the impression the one thing that was correct about MMT was that the Govt does in fact create money… and the bond market is simply an after the fact way of controlling this money.

    Even if we can all agree that the Govt has forced the PD’s to be their “money creators”… it still comes down to Congress deciding how much it wants to “create”. Lot’s of quotes when talking about this stuff because the meanings are always complex, lol.

  80. I think this is a grey area to me. Yes inside money is a liability to the banks, but they can also create deposits for the Govt, which they then use to increase our deposits. To me that means this still means the Govt has the ability to at least force an entity to create money for them. It’s not the Govt’s liability, but it also does not require the nonbank public from going in to debt to acquire those deposits.

  81. Paul, you write “Yes inside money is a liability to the banks, but they can also create deposits for the Govt, which they then use to increase our deposits.”

    What do you mean by “create deposits for the Govt?” Are you talking about, for example, a TT&L deposit account created by a private bank for the Treasury as a result of (a less common form) of bond sale during a Treasury auction (i.e., directly to a PD)? That is analogous to the PD making a loan to the Treasury just like the bank makes a loan to an individual. The “inside money” is created ex-nihilo (as Cullen likes to say) in a private sector asset/liability pair, only the asset in this case isn’t called a “loan” its called a Treasury Bond, even though it acts just like a loan.

    Technically, the government must request that this TT&L account be transferred to its Fed reserve account before the gov can make use of those funds. This is exactly analogous to an individual moving his deposit from Bank A to Bank B: the bank in this case must come up with the reserves (bank assets) to transfer. The TT&L account is debited the same amount of the transfer. When the gov spends these transferred funds, yes, they do it by indirectly (through the banks) increasing the gov payee’s deposit account (and the payee bank’s matching reserves).

    A different auction mechanism is more common through “repos” as Cullen has described… but the upshot in both cases, I believe, is that when those reserves are transferred to the gov’s fed reserve account, the private sector bank has to come up with them!… either they borrow them from other banks, obtain them by attracting deposit transfers from other banks, obtain them from the money markets, sell treasuries to the Fed during OMO, or, as a last resort, borrow from the Fed discount window. So is that the sense in which the “Govt has the ability to at least force an entity to create money for them” that you state?

    Yes, far from “the non-bank public … going into debt to acquire those deposits” (by “deposits” here I take it you mean the gov’s reserve deposits), the non-bank public actually trades their low-paying deposit assets for other higher-yield assets (repo-agreements, most likely, through money market funds).

    OK, so how did I do? Sound plausible?

  82. I think this is over complicating the issue. The Treasury disburses funds to real individuals accounts. So real people receive real money that was not created by another nonbank individual going in to debt. So for the nonbank public this is an increase in money, money we can use to pay off our debt, pay our taxes, etc.

    The inner workings of how the PD’s and the Fed funds this spending by the Treasury is behind the scenes of the Treasury disbursing the money to the nonbank public through the Fed. And even through repos, I still do not see how PD’s purchasing treasuries from the Treasury does not result in an increase in deposits.

  83. Govt deficit spending is a redistribution of bank deposits. Think of the Tsy Direct system as it’s the cleanest example. It’s deposits in, deposits out, plus NFA as bonds.

  84. Paul, check out this tool:


    It will allow you to visualize the TT&L route of a Treas. bond auction (bottom two operations on the pull down list), and I think address some of your questions.

    Try a bunch of “Treasury Issues Debts” ops followed by a bunch of “Treasury Moves Funds From Bank” ops … eventually the bank(s)will run out of reserves for this latter operation to satisfy the Treasury’s demands. So where does the bank turn? (Unfortunately the banks are consolidated as one entity on this tool, otherwise you could turn to other banks). The “households” and “companies” still have deposits, but there are no more reserves at the bank. This is where the Fed steps in with OMOs to “Lower Rates” (another op on the tool) to swap the reserves for those treasuries still at the bank… … or try “Government Spends” which puts gov reserves back into the banks… and then the bank can continue to meet the demands of the gov for reserves).

    Nobody in the private sector goes into debt (non-bank or bank) to support this government acquisition of funds through the auction or the subsequent spending.

    The tool has it’s limitations (no “repos” for example), but it can help to visualize how all this plays out on the main actor’s balance sheets.

  85. What Cullen said above can be done on the tool using the ops “Government Issues Debt” (the treasuries go straight to households there), followed by “Government Spends.”

  86. But the “deposits in deposits out” only occurs when the nonbank, non foreign sector purchases treasuries. When banks or foreign central banks purchase them (which is the majority of buyers from the Treasury)… we are left with an increase in deposits.

  87. Right, but that’s not the way most of these transactions go down. The intra-day loan that a bank creates at time of purchases is exited in most cases which results in no govt increase in money.

  88. Tom, I’ve seen that tool many times. One other piece they are missing is foreign transactions between CB’s. That tool just confirms what I’m saying, in that when the Treasury disburses funds, the nonbank public’s equity increases. This means we now have debt free money. So even though the inside money is still a liability to the banks, the process between the banks and the govt still ends up with more deposits in the system. The only way it doesn’t is if deposits are used to purchase the debt.

  89. Paul, if I go through one op each of this:


    The simple “treas direct” method Cullen described… perhaps you don’t have an argument with that method.

    I see the result is not more deposits in households… it’s more treasuries owned by households, and more equity (like you say).

    I think that Cullen’s “repo” method is just a more complex way of essentially accomplishing what the “treas direct” method does (except perhaps with other non-bank players rather than households), and he claims that’s the most common method. Agreed, no foreign CBs modeled though.

  90. I understand the treasury direct method and when people on the secondary market use their deposits to purchase treasuries on the secondary market does not result in a net increase in new deposits. In normal times when the economy is growing and private debt is normal levels, it makes sense that majority of Govt debt will be consumed by private savings.

    However, when you have situations like we just ran in to where we are issuing trillions a year, the private sector is not soaking that up. The PD’s are soaking it up and the Fed in return is soaking it up off the PD’s. This 100s of billions of dollars in treasury purchases from the PD’s by the Fed is in fact leaving the nonbank public with a lot of debt free money as reflected by the increase in the money supply while bank credit remained stagnant.

  91. The only point I was trying to make has been settled:

    “Bank reserves are not the same as checks or credit cards, etc. – accounting 101.”

  92. The PDs short term borrow to buy the Treasuries, frequently via repos (as CR pointed out via his Fed source). Reserves can work in the place of repos too.

    The PDs then pay back the repos (or reserves, etc.) when they sell the Treasuries to the Fed during POMOs or certain forms of QE etc.