Here is the diary form of my comment:
This one lost me:
The outcome is that all mainstream economics is based upon a fundamental misconception through the reversal in accounting polarity that arises out of the ‘agency’ error. ie what is an accounting credit is assumed to be an accounting debit and vice versa.
It depends on whose books you are looking at. One man’s credit is the counterparty’s debit.
The Fed’s relationship to the Treasury is indeed an agency relationship, not a counterparty relationship. The Fed is an agency of the federal government, whose board is made up of public and private (national bankers, community bankers, other appointees) governors at each of the regional banks. And those banks collectively govern the Fed through the Board of Governors that Ben Bernanke chairs.
The discussion of Tax and Spend (Myth #1) is way off. Taxing and spending do not enter into what the Fed does. The Fed functions as a permanent line of credit for banks and loans money to banks at a interest rate just for banks (the Fed funds rate). That loan increases the assets of the Fed and lowers the assets of the bank; the double entries on various accounts to record this transaction will balance out to zero.
Fractional Reserve System (Myth #2) is better but still sorta bass-ackwards. The money that the Fed loans the banks becomes a liability to the banks, but so do the savings accounts and other investments deposited by the banks customers. The assets that the bank holds are its loans. The fractional reserve system allows the banking system as a network (not individual banks) to create money in the money supply greater than the reserves held by all of the banks in total. Those loans in turn provide more money than the face value of the loan in purchases of goods and services, depending on how many transactions occur before that unit of money goes back to pay off a loan. It is a very complex network interaction that produces enough money to service the purchases of goods and services in the economy.
What the fractional reserve system does is keeps the banking system from running away creating more money than the production of goods and services can support, creating a bubble and a panic.
And the way that the Fed controls this is to require banks to keep a certain percentage of its cash as reserves. Now the cash combines cash that the Fed provided as a credit and the cash retained from the operation of the bank. Total both of those, take a regulated percent out, say 10%, and loan the rest. So the bank is not loaning out multiples of the money it has, it is retaining 10% and loaning out 90%. And charging interest on the loans, some of which goes to pay back the Federal Reserve.
That’s the operation of the Fed with regard to the money supply. It can control the money supply by raising or lowering reserve requirements or by raising or lowering the Fed Funds rate.
This is what Bernanke means by creating reserves in the banking system. It loans what banks ask for, subject to reserve requirements and the Fed funds rate. Because the Fed reserves assigned to a bank are a liability for that bank, the incentive for the bank is not to overborrow.
The Treasury issues debt in the form of many different instruments, but use the term T-bill to describe a bunch of what are essentially US government bonds sold for large (for ordinary folks) aggregate sums of cash. The Treasury auctions T-bills which sets the original interest rate. There is an aftermarket in which owners of T-bills sell to other private individuals, which has a different interest rate. The T-bill in this secondary market is discounted (up or down) for the changes in the risk that that T-bill might not have the same value later. But let’s leave that aside.
Through its loans to banks, the Fed makes a profit in terms of its cash account. That cash is available to be loaned. It is also available to purchase government T-bills to finance government debt. The Fed is a creditor just like private individuals or corporations or the Social Security Trust Fund. But it is a special sort of creditor in that it is an agent for managing US Treasury interactions with the banking system so as to manage the money supply.
The Fed can also buy T-bills from the private aftermarket or from original holders to be able to essentially retire that debt before the T-bill maturity date.
Now lets look at coinage, which is the government taking a material and creating a face value that is greater than its material value. In fact it used to be coinage that established the value of the material. A pound of silver (Sterling) had the value of 1 pound. Dollars were different. Dollars were worth 1 dollar, no matter what the material they were made of. So there was a dollar-to-gold or dollar-to-silver price. When I was growing up, the price of an ounce of gold was $35 and Fort Knox was the repository of all of the US’s gold assets. Our boom during the 1950s and the wars of the 1960s caused an outflow of gold to other countries–essentially inflation for the US. So Richard Nixon took us off of that system. Goldbugs have been delighted ever since.
The government prints currency out, not of thin air, but paper and various alloys of metal. These essentially circulate for small transactions not worthy of keeping money in a bank. (Remember money in banks is not currency; that’s just used to make change; money in a bank is magnetic bits on a hard drive that gives the total in some account or another. With debit cards, the money in the money supply is much, much greater than the currency.
So how does this relate to the debt ceiling? It would be perfectly legal for the Treasury to issue currency too pay off its debts directly. Before the Federal Reserve, the government used to do just that. And the Secretary of the Treasury has the authority to do it.
So what’s the catch? Well issuing money directly to pay off debt at the rate that the government spends would increase the money in circulation without the restraints of interest rates or reserve requirements. The Secretary of the Treasury would have to issue what had come due, not what was needed to support all transactions in the economy. The means of measuring its impact and adjusting the release of funds would make it difficult to avoid inflation.
The financial whizzes have an idea for how to draw down the debt without killing the economy either through contraction of demand or through inflation. The idea is to use a coin designed to be transferred to the Treasury’s agent the Fed to hold as a reserve that the Fed could then retire that amount the T-bills that it held as assets for managing the money supply. The illustration is a platinum bar marked with the symbol “$1 Trillion” or whatever denomination. The platinum itself would be a hedge against hyperinflation. If the money supply got dramatically out of hand, the Fed could sell the platinum bar at its metallic value and draw money out of the money supply.
The Fed gets a platinum bar and continues to manage the money supply. The Treasury gets the amount of the face value of the bar and can pay creditors and vendors which puts government cash and hence resources in the hands of folks outside the banking system. Which stimulated demand, jumpstarting the economy and raising government revenues so that at some point the Treasury can buy back the platinum bar from the Fed and retire it.
As the economy improves, more debt can be repurchased and retired ahead of time, unwinding the compound interest. And allowing more investment in infrastructure and other government expenditures that lower the cost of doing business in the future (and are counter-inflationary).
What matters is the balancing the money supply equally with the real wealth or the GNP. The wealth in goods and services are provided in a network of transactions that ripple in one direction in the economy and money paid for those transactions ripples through the other way and informs suppliers of supply and demand conditions. People have gotten so obsessed with the stocks of money in their bank accounts (or lack of it) that the forget that the real wealth is in the value added flows of goods and services. Which is why I say that American elites are the most stupid in the world.
The debt ceiling is mythical because the accounting reality in the government is that Congress has appropriated funds to be spent and passed laws that determine the amount of revenue coming in. Those two facts override any debt ceiling. As one wag put it, the pizza was already ordered and you’re saying that you don’t want to pay the pizza-man at the door. And the “no new taxes” pledge is designed to cut off the flow of funds to government, which might in a functional Congress go to project that lower the cost of living.
Sorry to be so long, but Chris Cook does not understand the US banking system and the federal reserve. Something a few hours reading the Fed’s and Treasury’s web sites would have cleared up.
