Early Thoughts on the Fiscal Cliff Deal….

Now that the clowns have left the tent we can make some brief assessments on the fiscal cliff:

  • A deal was actually finalized.  That’s good news.  It looked like we might actually go into January without a deal and that the odds of no deal at all were rising.
  • No one really won here.  Congress is totally dysfunctional.
  • There’s still a lot unanswered.  In particular, this doesn’t deal with sequestration or the debt ceiling.  So, this drama is far from over….
  • Ultimately, the big news is that the worst case scenario with $575B in cuts didn’t pan out.  That means the worst case austerity scenario didn’t occur.  That’s very good news.
  • BUT, this bill is more austere than current policy.   The biggest hit to the 2013 budget deficit is the payroll tax cut expiration which comes in at $126B and reduces middle quintile incomes by roughly ~$700.   Goldman’s Jan Hatzius has also said this will shave 0.6% from 2013 GDP.  Not good for an economy that is muddling through.
  • The other big chunks are the Affordable Care Act and the partial expiration of the Bush Tax Cuts which adds up to about $100B.
  • If my rough math is right we’re looking at something in the range of $225B in cuts out of a potential $575B.
  • The total drag on the economy (using the CBO’s fiscal multipliers and Goldman Sachs estimates) is ~1.3%.
  • Using the CBO’s “Alternative Fiscal Scenario” we’re still looking at big budget deficits in 2013.  I’ll let the CBO run the final numbers here, but my back of the napkin math points to something in the $950B-$1T range.
  • Remember, we’re in a balance sheet recession so government budget deficits are driving corporate profits to an unusual extent while private investment recovers.
  • The bottom line: this could have been much worse.  Unfortunately, it’s not completely over.

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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      • I wouldn’t dismiss that possibility. The private sector might not go “bonkers” but it could pick up a decent amount of slack. The public sector is still supportive with a budget deficit in the $1 Trillion range. I wouldn’t be shocked to see a 3 handle on GDP, perhaps in Q3 or Q4. Maybe even a 4 handle.

      • There’s always the ‘hidden’ inflation factor to crank up Mighty Mouse mode and save the day.

        NGDP is my hero. /sarc

  1. It’s not credit issuer, but user determine value of money.

    Argentine was the richest country in the world (base on per capital GNP) about 100 years ago.

    If US government simply employ more people to engage in non productive works, lots of US$ will be issued to those otherwise unemployed. At the same time, if Fed is accomodat ….. this is what some Monerytrists advocate. Theory is not reality.

    • The US govt doesn’t issue the money. The US govt redistributes money. The entities that issue money are banks. The govt redistributes money in two ways. By taking from Peter via taxes to pay Paul. Or selling a bond to Peter to pay Paul. In the latter case the govt issues a net financial asset in a bond. But this isn’t money creation. It is a security issued as net financial assets. Important point and a common myth that people hold.

      • Cullen,

        are you sure about this part of the mechanism:

        “The US govt doesn’t issue the money. The US govt redistributes money. The entities that issue money are banks. The govt redistributes money in two ways. … Or selling a bond to Peter to pay Paul. In the latter case the govt issues a net financial asset in a bond. But this isn’t money creation.”

        So when the govt issues a bond it does not sell it to Peter, it sells it to a bank. Now with what money does the bank buy the bond – existing or newly created via FRL? If it is the latter, then THERE IS new money entering the economy and it is clearly inflationary. And banks have lower capital requirements (or even none) for holding govt paper.

        • Investor X, that is an interesting question that has been discussed in here before.
          As it has been explained, the Primary Dealer buys the bond (using inside money) but then immediately sells the bond to savers. Practically speaking, the public is buying the bonds with savings and the primary dealer acts as agent. (My understanding.)
          Also, my understanding is that the primary dealers do not hold the bonds, that there is always demand for them.
          To your point, this raises an interesting question.
          1. The bond — as Cullen notes, this adds a net financial asset. What are the long-term ramifications of this?
          I guess it comes down to the question of when and if those net financial assets will be ‘spent’ into the system.
          The optimistic view is that there will always be more savers than spenders, or that even if they are ‘spent’ (bought out by the Fed) then this would be in a growing economy and would have no impact.
          The pessimistic view — I can’t articulate it, but the idea of net financial assets eventually growing to two or more times GDP seems like it would create problems, some of which probably we can’t even see right now.

          • “I guess it comes down to the question of when and if those net financial assets will be ‘spent’ into the system”.

            No. The government sells the bond in order that it may spend. So, there will necessarily be “spending into the system”.

            When this happens, the government credits private sector deposits at the commercial banks. In payment for the goods or services that said sector is or will be providing to the government.

            This is the spending that raises GDP. Unless the economy is already at full employment (a rather distant prospect in the present circumstances) in which case the spending will contribute to inflation.

          • Right. The banks on-sell their inventory divesting the non-bank public of deposits. This process is really rather simple. It’s inside money in, inside money out. Plus the bond buyer owns a bond which is the “money printed” if you want to call it that. It’s not really money, it’s a net financial asset….

            • When a corporation issues a bond, they sell it for money. But that is not called “printing money”. But it is the same kind of instrument to the purchaser as a treasury bond, without the “full faith of the government”.

        • If the bank buys the T bond or bill with pre-existing reserves, the Fed will debit the bank’s deposits at the Fed and credit the Treasury’s account.

          Then the Treasury will deficit spend by crediting households’ or firms’ deposits at the commercial banks.

          End of the story: there will be new money created – new deposits for the private, non banking sector.

          This new money is an asset to the non banking sector and a liability of the commercial banks.

          Thus, the Net Financial Assets created for the private sector as a result of deficit spending are the government securities – held by the commercial banks, in this example.

          • We’ve gone over this. I’ve already confirmed it with the NY Fed. The primary way t-bonds are bought is with existing inside money. The reserve settlement process does not alter the actual flow of funds, which is quite simple. It’s inside money in and inside money out. The govt spends when its account is credited due to the purchase of the bond with inside money. You need to stop conflating this process with the reserve settlement concept as MMT does. It misconstrues the flow of funds.

            Govt spending creates a net financial asset in the bond. It does not create new inside money.

            • The point is that the banking sector doesn’t use up any deposits in order to acquire the T bond in the first place – as opposed to what happens when it’s a non depository institution buying the T bond.

              The banks pay to the Treasury with their reserves at the Fed. The Treasury marks up its deposits at the Fed.

              Then the Treasury deficit spends. If it credits Mr. Cullen Roche with a $100 deposit for payment of consulting services, Mr. Roche (the private sector) has gained new money. And the banks, when the Treasury payment is made, will have plus $100 in reserves (regaining the reserves first used for buying the T bond) and plus $100 in a liability, the $100 deposit owed to Mr. Roche.

              So, in net terms, a new deposit (inside money) was created where hitherto there was none.

              I’m sure your Fed source will agree on that – because it’s simply the only logic of accounting at work.

              • That’s the point. The “primary” way t-bonds are purchased are with funding from a non-bank so your whole example is a moot point since the inside money that’s created initially is only temporary. The intra-day loan is temporary so the banks don’t actually fund the spending. It’s repo’d out intraday. We’ve been over this. You’re now misconstruing the point to change it to banks buying the bonds and holding them when the funding source is primarily non-banks. Banks on-sell their inventories of Tsy’s. There is no new inside money created in this process. You can’t just move the goal posts to prove MMT right when it’s primarily wrong. The reserve settlement process in this has nothing to do with funding the actual t-bond purchase.

                I’ll post the Fed source quote again. Note “primary”. He’s not describing your example because it’s not the primary way bonds are purchased.

                “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 so you can quibble with it and alter it to your liking, but you can’t change the facts. And the facts are that there is no new inside money created through this process. It’s inside money in, inside money out PLUS NFA as bond. That’s the “primary” way bonds are bought. And the flow of funds is clear no matter what you say about reserve settlement. You really need to stop confusing people on these matters and misconstruing the argument so that MMT appears correct when it’s obviously not.

                • Hm this is interesting. Cullen, did you do a post on this that I missed? I’d be interested to know why this is the primary way, when different methods are used, and what the economic differences between the methods are.

                • Let’s recap the argument.

                  When non banks finance the deficit (which is the “primary way” for funding in the U.S.) no inside money is created.

                  When banks finance the deficit (according to the your Fed source, a rare or non-primary instance in the U.S.) new deposits – inside money – is created.

                  And “MMT” has got nothing – repeat, nothing – to do with this. It’ all pure accounting.

                  So, let’s agree on these two points and move on to other interesting matters.

                  Btw, I find it a bit funny when certain schools of economics claim as a great breakthrough on their behalf results that are simply the consequence of following through a few steps of double-entry bookkeeping.

                  We’d all gain by ceasing to obsess about labels and start thinking in terms of the simple, plain pursuit of a correct theoretical description of the monetary system.

                  • I understand the MMT reserve settlement accounting. I understand it better than most MMTers understand it. I am telling you it’s a conflation of the flow of funds. The flow of funds in money that matters is simple. It’s inside money in, inside money out PLUS NFA. You can consolidate the Fed and Tsy balance sheets (which is wrong to begin with) and then say that reserves were issued (which is monetary policy) or whatever, but you shouldn’t obscure the clear flow of funds in the real economy. Saying that the reserve settlement process matters here is like saying that the Fed’s bond holdings matter for the domestic private sector. MMT can’t hold both of these positions at the same time. THEY CONTRADICT ONE ANOTHER IN VERY CLEAR TERMS! If MMT were consistent on this they should call QE money printing since they now claim bonds are money (which is absurd) and at the same time want to claim that QE isn’t really money printing because the Fed’s holdings are not held in the domestic private sector. But the accounting says money was printed! After all, it’s accounting! There are so many inconsistencies and mangling of definitions that I can barely list them all….

                    • “The flow of funds in money that matters is simple. It’s inside money in, inside out PLUS NFA”.

                      Operative expression: in what matters. The “primary way”.

                      A primary way implies the existence of a secondary way – where banks finance the deficit. And in that case there is net creation of deposits – money.

                      Also, I’d like to clarify that contrary to what you seem to be implying I do NOT think T bonds are money. You’re misrepresenting my position on this matter.

                      And your rambling against MMT does not concern me, frankly. I don’t represent that school of economics – in fact most of those who follow these subjects don’t belong to any “school”.

                      Many people do prefer to use their own powers of reasoning instead of slavishly following “schools”, however fancy these may seem :)

                    • Well, please accept my apologies then. I just assumed you were MMT since you’re making MMT-style arguments and seem to defend their ideas or spend q good deal of time on their websites discussing MMT.

                      And yes, of course there are secondary ways. There’s Treasury Direct, there’s pvt banks buys and holds, there’s pvt bank buys sells, there’s broker dealers, central bank secondary market purchases, etc. There’s even theoretical stuff like the trillion dollar coin or just letting the central bank buy on the primary market. But I focus on the primary one because it represents 80%+ of the transactions. But none of this has to do with the way MMT describes anything. MMT wouldn’t even start to say bonds fund govt spending. So we’re talking from two totally different perspectives to begin with. I get the MMT accounting ideas and all. I just don’t think it accurately describes the flow of funds in the real economy. It obscures what really happens between the institutions to make a “general” case conform more with a “specific” case. Frankly, the fact that MMT even has general and specific cases is enough to prove that even MMTers MUST admit the current monetary design isn’t actually MMT…..But I am tired of discussing these matters. Again, sorry if you don’t consider yourself MMT. Maybe you’re MR? :-)

                    • MR fellow traveller? :)

                      One thing I feel is characterizing many MMT proponents lately is a certain unwillingness to face new facts, as if their theory were already completed, perfected and thus never in need of further improvements or developments.

                      One small example: some months ago discussions over the nature and implications of the TARGET2 payments system on the crisis of the eurozone were all the rage. MR produced a seminal paper (JKH’s) on this subject. Where are the MMT-based studies on this very important topic? I’m aware of none.

                      I once tried to question Warren Mosler on his views on the subject and he wasn’t very open to discussion, to put it mildly.

                      Maybe the founders haven’t found the spare time that is necessary to study new topics in depth. They’re only 6 or 7 people in total with lots of demands in their agendas so I don’t blame them for that. But IMO they should not act as if their theory were the crowning intellectual achievement of humanity – so perfect that it can be impervious to honest criticism and closed to further adaptions to real life facts.

                      A static theory is – or is always at risk of becoming – a dead body of thought. Humility must remain a trademark of the scientific approach to evidence. I think it’s particularly frustrating to watch the rather lame analysis of MMT on the continuing developments in the eurozone – a topic I consider to be of the utmost importance for anyone interested in how monetary systems evolve. Where has MMT made the crucial distinction between strategic and operational issuers of the currency, so relevant for analyzing the eurozone? It hasn’t – you have to go to MR to find it.

                      So it does seem we have people with a more dynamic approach in the study of evolving monetary systems (MR) that contrasts with the rather conservative attitude of many MMT proponents – who are perhaps relaxing a bit as they keep writing new words on the same old topics with the same old static approach all over again.

                      That’s the reason I think competition between MMT and MR is a very positive development. The emergence of a competing school may well guarantee that monetary theory will not get stuck in the past and will be forced to evolve just as real life keeps evolving.

                    • Great thoughts Jose. Thanks. I agree. I think one of the big problems in economics today is this static view of the world. Most economists have a sort of one-size-fits-all view. If you’re a new Keynesian you always promote countercyclical policies. If you’re an Austrian you always promote anti-govt policies. If you’re a monetarist you always focus on Fed based policies. If you’re MMT you always promote the JG. I don’t think the world is so black and white. There is no one-size-fits-all theory or policy agenda. You need to start from the ground up. You need to understand the system for what it is and then understand how the current environment is applicable to that understanding. That’s why I think MR is so important. We aren’t starting with policy at all. We’re starting with operations and institutional design.

  2. Good point about the payroll tax increase. I wonder how many people are going to see a smaller paycheck in the next two weeks and say, “Hey, didn’t they vote not to raise taxes?”

  3. The debt ceiling can not be breached. The sequestration will go into force in two months. Tax cuts have been made permanent……. where does Obama go from here? What am I missing? Obama is in check mate as he has nothing left to negotiate with. Social Security reform? Medicare cuts? Revision of the healthcare taxes?

    This is far from over….. sell into any knee jerk reaction??????

    • A deal can be made on sequestration because the current CR runs out in 2 months, and full year appropriations MUST be passed. The debt ceiling can be circumvented with a trillion dollar coin. If Obama is going to do the TDC, he will probably threaten to do it first as a prod for Congress to act, probably in the State of the Union Address. If he shows us some nice shiny trillion dollar coins on that night, Congress had better take him seriously, because he will deposit the TDCs with the Fed if they don’t.

  4. •$222 million for Puerto Rico and the Virgin Islands through returned excise taxes collected by the federal government on rum produced in the islands and imported to the mainland.

    This one is interesting in that it shows how US Govt not only realocates inside money, but also how Jobs can be realocated as well.

  5. So $225b in higher taxes equals 1.3 pct GDP?
    That just seems like scare tactic nonsense to me. If that formula worked, then the stimulus would have created growth, or the previous payroll taxes would have created growth.
    Or heck, $1 trillion in deficit spending would create 5 pct economic growth.

    • You’re not factoring in deleveraging. If the private sector “destroys” $1T worth of their debt, and the Gov spends $1T in deficits, it is $0 to the economy (to be accurate though you need to factor in the trade deficit… so $500B going to trade deficit require $500B either in gov deficits, or private sector debt or a combination to net to $0)

      • But deleveraging is good for the economy, isn’t it?
        When the consumer pays off his car loan, that helps the economy. He can now spend his money in more productive ways than paying interest. He can take another loan.
        Deleveraging is neutral. It destroys the asset (the debt) but also the obligation.
        What I am missing?

        • Yes, it is good for the economy, but during the deleveraging process money is being spent by the consumer to extinguish his/her debt obligations, not on purchasing goods and services. That’s Hangemhi’s point. Depending on the amount of the deficit, GDP will not necessarily grow during a deleveraging, but the deficit spending helps it to at least not contract.

          • Exactly. I was addressing Johnny’s “If that formula worked, then the stimulus would have created growth” comment. The reason the stimulus doesn’t appear to have worked is because it was money flowing into the economy, like water into a bathtub, while just as much money was flowing out, like the drain in the bathtub being open. Had the stimulus not happened the economy would have kept crashing (empty bathtub). So yes, Johnny, deleveraging is good. We need it. But if we have deleveraging without offsetting deficits/stimulus, then it become a Depression with a capital D. Deficits have allowed the private sector time to delever without massive jobs losses and destruction of asset values. Austrian’s like to argue that destruction is good and necessary, but I disagree.

  6. What about the increase in capital gains and dividend tax? Shouldn’t be a lot. But just curious.

    • @George, good point. Cullen, would you please approximate how much the increase from 15% to 20% in the cap gains tax & dividend tax will bring into the gov’t? It only applies to those earning over $400K, but still it must bring in another $20 to $25 billion or so is myrough guess. What do you think, Cullen?

  7. Not to worry. The Fed and the Government will do anything in their power to inflate the (nominal) price of assets. Feel free to stay long anything that moves and ride the never ending bubble. The number involved in the Fiscal Cliff are pathetic, and yet the markets are running like there is no tomorrow. This is all the politicians really cared about. The real economy no longer matters.

    • … but just because most are still convinced that sooner or later the economy will pick up and we will see 3% real growth again. There are a lot of well funded arguments that this will not happen, if not for a quarter or two, and one day the sand castle will go down. What one has to to is stop reading the propaganda and learning or relearning about the principles of thermodynamics: in a finite world that’s getting overcrowded and where resources are depleted at a much faster rate than replacement, endless material growth cannot happen. We can have endless knowledge growth, but it doesn’t produce output, that is it doesn’t feed a debt fueled economy.

  8. To speak of our elected representatives as “clowns”, Mr. Roche, is not fitting of your message.

    The American people if not overwhelmingly, decidely voted to keep Mr. Obama in office along with roughly the same divided Congress. That decision has consequences, and I don’t mean this in a fit of right-wing snark either. For democracy to have any meaning, elections have to have consequences, and we have to accept the wisdom of the electorate in deciding on those consequences.

    Mr. Obama is unabashed in his opinion that higher-income Americans need to pay more in taxes, not simply as a plan (in his view) to advance the economy but as a matter of Social Justice. A person can be fer it or agin’ it, but that is pretty much what the President has been saying over, and over again.

    With respect to the fiscal drag of the relapse in the Payroll Tax, this is another matter that falls into the category of the Social Contract of the people with their government rather than a pure economic decision. Yeah, yeah, and again yeah, that Social Security is in reality an annuity or a retirement savings plan is an accounting fiction, but it takes on the appearance, not of a welfare program but of a government mandate that workers save money out of their paychecks and get that money back when they retire. The (now temporary) payroll tax reduction made it more difficult to “keep up appearances” in that regard.

    Given the outcome of the election, do you see that there was the most remote chancee that taxes would not go up, maybe a little bit? Maybe we should have kept the payroll tax cut, but making that permanent, as I just mentioned, undermines the social myth, the story that we tell our young people paying the payroll tax, forming the long-term foundation for the old-age social programs. With respect to the tax boost on upper incomes, the choice was clear, and if the people didn’t want that, they would have, could have, and should have cast their votes differently.

    Given the outcome of the election, and given the deep ideological split in Congress, where there are also fewer “RINO” Republicans and “Blue Dog” Democrats, I cannot think of a better outcome to the Fiscal Cliff than what we got. We tempered the tax increases (a lot) that the President and the Democrats wanted, and we “kicked the can down the road” on the spending austerity that the Republicans and especially the TEA Party wing wanted.

    Furthermore, Mr. Obama was elected on bringing about a kind of “New Politics” free of the kind of “partisan bickering” that seems to annoy you and others. From what I have heard about Bob Woodward’s The Price of Politics, what Mr. Obama promised is a distant memory as he has proven himself to be a particularly poor negotiator. He doesn’t seem to be able to negotiate with the IOC over the Olympics-in-Chicago, with the leaders of China about Climate Change, with the Iranians as he onced promised, and the Conservative Republicans may as well be the Iranian religious leaders inasmuch as their beliefs being strange to Mr. Obama’s life experience.

    When a deal finally was reached, it was (apparently) hammered out between Senator McConnell and Vice President Biden, a pair of aging, highly experienced, old-style political dealmakers, if there ever where any to be found in an age beyond Dirkson and LBJ. So much for Mr. Obama’s transformation in politics. And the deal was reached that way, in the 11′th hour, only because all of the New Age-y alternatives were exhausted.

    Mr. Roche, I may not have your smarts in economic theory and the financial markets, but I think I have an advantage in life experience. I like inter-partisan bickering, I like political dealmaking, I embrace the old-fashioned style of politics. Given the realities “on the ground”, I cannot think of a better outcome than what Congress put forward last night. Clowns? I may not be a financial genius, but I have always lived by the belief that bad things don’t come to a person from showing one’s elders a modicum of respect.

    • I was just being playful. Washington looks like a circus these days. Clowns, circuses….you know? It was probably not in good taste. Sorry.

      • I don’t think it’s that far off the mark Cullen. Honestly I think if their were fewer cameras to posture in front of I think fewer politicians would be so uptight about keeping up appearances to the bases (both parties).

        Just an observation.

        • Dang it I hate when I misuse their, there, and they’re. My 2nd grade teacher must be rolling in her grave every time I post on the web.

          • at least you didn’t confuse lose and loose. that one drives me up a wall and seeems too bee happeening moore eeveery daay

  9. In the end it is better than nothing and proves that a some below the bottom of the barrel level of desirability the Congress can still pass legislation that absolutely has to get done.

    Problem is that they still don’t know how to make good legislation at all, and only make deals of minimal effectiveness when guns are pointed at their heads.

    Still. It’s better than I expected for one. Happy New Year Cullen!

  10. Piping in from the housing perspective here.

    Looks like private mortgage insurance got a break, and is once again a tax deduction.

    Also, the debt forgiveness was extended for another year

    “homeowners who experience a debt reduction through mortgage principal forgiveness or a short sale are exempt from being taxed on the forgiven amount.”

    Nothing happened to the mortgage interest deduction, probably will be something that is tossed into negotiations for later.

    http://www.housingwire.com/news/2013/01/02/mortgage-industry-fares-well-fiscal-cliff-deal-debt-forgiveness-law-survives

    Happy New Year Cullen, thanks for what you do here.

    • Roger, what are your thoughts on the MTG deduction?
      I think the mtg deduction is a prime example of how the gvt distorts the system.
      The main thing I gather is that once Uncle sam get’s in Bed with a concept, it’s pretty much married it and distorts it’s bride for ever.
      Housing, Healthcare, Education.. Heck in 10 years you will be hearing about Pot Smokers pissed off that govt subsidies to pot growers has caused the price of weed to spike.

      It’s as though we have handed to big a hammer to the FED’s somehow and now how do we get it back?

  11. When you say this deal is more austere than current policy, do you mean pre-fiscal cliff? Wasn’t current policy large automatic spending cuts and the expiration of various temporary tax breaks?

      • Help me understand this. There is more actual currency in use in America now than there was in the past. It seems a nations economy can’t be larger if the currency valued amount transacted is constant. 300 million people cannot do business with the currency value available in 1913. Add the lower purchasing value of the present Dollar and it appears the Treasury is printing more Dollar bills than needed to make up for those actually worn out. I realize many transactions you describe occur without the actual exchange of Dollar bills. But without so-called “printing more money” what am I missing?

        • It’s important to understand what money really is in our economy. Money is primarily deposits that exist as a result of loans. The money supply is elastic in this sense. It can expand and contract with loans. But it primarily expands with time since loans increase as businesses grow and the needs of borrowers grow. Currency, or cash & coins primarily, facilitate the use of inside money (bank deposits). You can’t access cash unless you have a bank account (someone has to have withdrawn the cash from their bank account). So cash facilitates the use of inside money.

          • Cullen,

            Can you eventually do a video for us mere mortals. I’m learning a lot but I’m far from a professional.

            Thanks

          • Cullen, Again I must thank you very much for your newly improved primer “Understanding the Modern Monetary System”. Part V – Understanding Modern Money, says “”Money” is a vague term. Technically, anything can serve as money.” But then in trying to keep things understandable for Midas II, you seem to be using the term “money” in a very specific way that confuses me. In your answer I think you are writing specifically about US fiat dollars, of which there are two kinds, (1) those created by banks “inside money”, also called “credit” that carries with it interest payments, and (2) those created by Uncle Sam-Fed Reserve-Treasury “outside money” that are also US fiat dollars that don’t carry interest. By far most of the newly created US fiat dollars are within the banking system e.g. the funds created out of whole cloth that create a deposit as well as a loan (Credit). The “outside money” is a pittance compared to that; although $16 trillion sounds like a lot! When the Fed failed to control credit creation that’s when we had inflation. These days we don’t have a lot of excess credit creation, in fact the opposite, and according to your MR write-up the Uncle Sam-Fed Reserve-Treasury “outside money” is helping to defeat deflation. So the answer to Midas II is that it’s not the Fed Reserve printing paper notes that controls the up and downs in the size of the economy it’s how much credit has been extended by the banks. My understanding is that the Fed, by (1) trying to control inflation and (2) trying to help foster employment, actually boils down to trying to control credit creation by the banks and non-bank institutions–a very difficult job considering the current circumstances. During 2005-2008 enormous amounts of credit US fiat dollars were created (debt dollars), that when up in smoke in months. That took $ many trillions out of the economy, so Midas II need not worry about inflation via Uncle Sam-Fed Reserve-Treasury “outside money” for years to come.

          • So, when I get paid, it is because my boss withdraws money from his bank account (a simple example). Thanks for the reply.