How Money is Created through Debt in our Fiat Economy -- Starting from Scratch

Sure I can. I spend my deposit money all the time. The fact that banks transfer reserves between each other does not mean that I don't use my deposit money to purchase real goods and services.

No, I still do not see it. Since I have clearly said from the very beginning that bank loans do not create reserves and the Fed has to create reserves in order to make Government spending usable in the real economy. The money is created by the Government creating a deposit... the Fed's simply make that deposit convertible in to cash and allowing banks to leverage more reserves by creating loans/deposits

When the Govt funds a military members account, that is a NEW DEPOSIT. The bank did not create that deposit. The Treasury did through their account at the Fed.

It's an everyday process. The Fed's just bought $800 billion of treasuries from the Primary Dealers. The Primary Dealers purchase over 70% of treasuries issued. The fact that they do not hold them in the secondary market has nothing to do with them not funding the Govt like they create loans

Yes, but this is no different than the bank buying it and then you buying it in the secondary. Like I showed, when you purchase the debt from the bank, it's like nothing happened except the private sector has a new asset in the form of Govt debt. So it really doesn't matter if you use your deposit money first or second. The accounting is no different.

Deposits are destroyed when the debt is purchased from the Primary Dealer (market makers). After that nothing is created nor destroyed.

No, I have demonstrated this to you in complete detail. When the bank sends reserves to the Treasury, the Treasury uses those reserves to create deposits. A deposit is gained from Govt deficit spending until that spending goes to purchase Govt debt.

False

Yes, but now the Fed has the chance to convert these Treasury's in to reserves to allow the banks to lend more. But a deposit was CREATED by the Government spending.

 

If (and only if) the Primary Dealer were a bank that doesn't have a separate deposit account, that is true.

OK, I agree, it is a new deposit, until the Prime Dealer sells the note to a non-bank investor, a which time the new deposit disappears.

That's why we need to be clear on the terms. I agree that if a bank buys a Treasury (and doesn't resell it) then a new deposit is created. But new reserves are not being created. That was the point I was making.

I didn't say you did. I was explaining why Govt spending has no effect on the amount of reserves in the system.

Depends on how you define money.

Only if: 1) the spending was funded by a loan 2) from a bank 3) which holds the debt.

Because it is the bank lending money, not the Govt spending it, that creates more deposits.

If the money the Govt spends if from taxes, then the deposit account of the tax payer decreases, which offsets the increase deposit account of the recipient of the Govt expenditure.

Similarly, if the spending is funded by a non-bank entity buying it, the non-bank entity's deposits decrease offsets the increase deposit account of the recipient of the Govt expenditure.

And finally, if the bank bought the Govt Treasury, but then sold it, the decrease in the account of the person buying the Treasury from the bank would offsets the increase deposit account of the recipient of the Govt expenditure.

Since banks hold maybe $100 billion of the $14 trillion or so of Govt debt, that expansion of deposits is are relatively small amount.

And the net effect of even that small amount of deposit expansion would be zero, if you assume the bank would have made a loan to someone else if it didn't make it to the Govt by buying the Treasury.

 

The administration has not pumped trillions in the system. The Govt does not expand the money supply, the Fed does. The Fed has added about a trillion into the money system.

I disagree that is the reason banks aren't lending.

 

If you believe that there is no connection between the Fed and this WH, that is your right. as to why banks aren't lending, there is no demand on business to expand, notto mention the uncertainity generated by the WH.

 

Primary Dealers do not use deposit accounts to purchase treasuries. They use reserves. It is nothing but an asset swap. Look at my T-Accounts. That is how the country operates. Just saying words makes it impossible to visualize.

Correct

I agree

Well, technically it does in the sense that they first have to take reserves out of the system before they can spend. But in the end, yes it has no effect on the amount of reserves.

Well since Primary Dealers are mandated to purchase Govt debt, it's just a matter of definitions. Yes the bank has to "loan" money to the Govt to spend... but they are mandated to do so by the Fed/Govt.

True

True, but there is a new ASSET floating around the private sector. The balance sheet of the country has grown.

Yes, there is a new asset though. That is the point.

That doesn't matter in accounting terms. The fact that most of the time a deposit is created before the treasury is bought in the secondary market is all that matters. Govt deficit spending creates assets, whether they be a household holding the note or a household with a deposit.

The Fed's purchased $800 billion in Govt debt off the Primary Dealers balance sheet just last year. That is 8% of the public debt outstanding. So the current bank numbers might seem smaller than usual.

The point is it absolutely doesn't matter. That is why you have to focus on the accounting of how the system works. Do not focus on the money. The Govt does not need the Fed to create money in order for them to spend. The Fed needs to create money in order for Govt spending to be usable in the real economy and for banks to be able to create loans.

The Govt is absolutely dependent on no one to spend money.

 

No, got back to step 6 of the MMM. Have you read it?

You do decrease your deposit account, but it is the transfer of reserves that effects payment.

Step 6, MMM.

And as I pointed out, if your bank were to have a run (without FDIC insurance) you can have a million in deposits but you can't spend a dime.

The amount of the reserves (base money) in the system determines the ultimate amount of money (including deposits) in the money supply.

If you disagree with that, we will need to go through the system of how money (deposits) are multiplied from the amount of base money (reserves) injected into the system.

See my post above. If and only if the three conditions are met.

Remember, it is the bank lending reserves without decreasing deposits, and those lend reserves in turn being deposited into a new deposit account, that creates new deposits.

See comment above on Primary Dealers. The fact they buy them don't have an effect on deposits unless the Primary Dealer is a bank, doesn't have a deposit account, and does hold the debt.

No, there is big difference. When you buy it from a bank, your deposit goes down, creating a net decrease in the amount of deposits, which offsets the increase deposit account of the recipient of the Govt expenditure.

Right. And that "destruction" offsets any deposits created by the Govt spending.

There still reserves in effect. When the Govt gets $1 trillion in reserves and deposits it in its account and then spends $1 trillion in reserves, there has been no net change in bank's reserves or overall reserves in the system.

It is quite true! See my example explaining the three necessary conditions in my prior post.

That is correct.

If an only if the three conditions are met: 1) the spending was funded by a loan 2) from a bank 3) which holds the debt.

 

No, all that transferred for me was my deposit account to someone elses deposit account. The reserves transferring between the banks have absolutely no bearing on the private sectors deposit.

That's only exchanging reserves for currency. As long as people keep money in their deposit accounts it does not matter how much someone uses from their deposit account because the reserves just get transferred within the banking system. Just because a bank loses it's reserves doesn't mean the deposits lose their ability to use their deposit accounts to spend money.

In an accounting sense yes, in reality no. The Government determines how much money people have. The Fed determines how much money the banks can leverage... that is it. The Govt is not dependent what so ever on the Fed for creating accounts.

I know. I have said the same thing from the beginning. The Fed is responsible for creating usable money. They are not responsible for how much money the Govt can spend.

Yes, but they are mandated to do so. It is simply the way the system works. Either the Govt can spend whatever it wants and maintain seigniorage over the money issuance or it can use an intermediary and make the banks create money for them

All Primary Dealers are banks

Yes, but I now have a new asset. The asset is what matters when Govt spends. The debt is an asset to the private sector and a liability to the Govt. It is this debt that the Fed uses to increase reserves, it is this debt that banks buy to fund the Govt. It is all dependent on this note that the Govt creates.

But a new asset exists

Correct

Accounting wise it simply doesn't matter whether the bank holds on to it or not. It will just change how the Fed reacts and whether or not they will create more reserves in the system or not. When you purchase debt from the Primary Dealers you are reducing deposits in the system essentially allowing the banks to create more deposits. But you still hold on to an asset. That asset is the basis of the how money works in our country.

Everything is completely dependent on how much the Govt spends. The rest is just how the Fed wants to manage this spending.

 

That is part of it, but we also are seeing banks being far more picky about the criteria required to make a loan.

The biggest uncertainty we've seen was the Republican Tea Party debt ceiling fiasco.

 

I don't know if that is true, but it is irrelevant. The dealers don't how the debt they resell it to non-banks. The non bank purchasers of debt decrease their deposit accounts when they pay for it, offsetting the increase in deposits by Govt spending so there is no net money creation.

right

But then they Dealers turn around and sell it, decreasing deposits and offsetting deposits created by Govt spending.

That asset isn't money by any normal definition of the term.

Any and every loan creates new assets the same way -- but they all increase corresponding liabilities as well. In the Govt's case, more debt.

All that matters is who ends up holding the Govt debt. If it is not a bank (as is the case with the vast bulk of the Govt debt to the public) there is no net increase in deposits.

When the Fed purchases debt, new reserves/cash/base money is created. This expands the base money supply. When the banks lend that newly created reserves/cash, deposits are expanded.

We're talking about how money is created and I shouldn't focus on the money?

It absolutely matters, because it explains why Govt spending doesn't result in a net increase in money - deposits or reserves.

I don't know what you mean by "the Govt does not need the Fed to create money".

I agree it doesn't, because it collects reserves thru taxes and borrowing and spends that.

In that sense I agree the Govt doesn't need the Fed to spend money.

The Govt depends on tax payers and lenders to spend money.

 

But what effected the transfer from your deposit account to someone else's was the transfer of reserves from your bank to someone else's bank which create the deposit.

No. You could have a million dollars in your account and write a check but if your bank doesn't have reserves to transfer the check doesn't get paid.

If the bank doesn't have reserves, it can't transfer reserves to pay your check.

In an accounting and real sense.

We shall see.

What is "usable money"?

I'm not aware of any such mandate on banks. They do it because that is their business and how they make money.

http://newyorkfed.org/markets/pridealers_current.html

I don't think those are all banks, see Canto Fitzgerald for example.

But the crucial fact is that these dealers sell most the Govt debt to non-banks which offsets the deposit created by Govt spending, so there is no net increase in deposits - or money.

As is the case with every loan, there is a new asset (not receivable) and a corresponding liability (note payable). That asset isn't money, though.

It's not money.

If I take $100 out of my deposit account, loan it to you, and you deposit it, there has been no new increase in reserves or deposits.

There has been a new asset (IOU receivable) and a new liability (IOU payable).

It doesn't matter whether it is the Govt or you and I doing it.


Correct

Accounting wise it very much matters.

If the Bank holds the debt, there is no decrease in deposits.

If the Bank sells the debt to a non-bank, there is a decrease in deposit.

Since the vast bulk of the Treasuries are eventually sold to non-banks, the vast bulk of treasuries result in a decrease in deposits offsetting the increase by spending.

Just as if I loaned you $100 instead of a bank.

Because it is only bank lending that increases deposits, since when the bank transfers the reserves to pay for the loan which are then deposited, there is no corresponding decrease in deposits at the lending bank.

Unlike a loan from a non bank, which does result in a decrease in deposits.

When I buy a treasury, the net effect is deposits decrease, offsetting the increase in deposits from spending.

The Fed doesn't manage Govt spending.

 

Iriemon, the transfer can still go through without the bank having reserves. The bank will just have to acquire the reserves from the interbank market afterward and will be in deficiency with the Fed Bank.

False

It is a completely behind the scenes process. All banks do is deduct deposits, then increase deposits... then acquire reserves later.

Money which can be used to purchase real goods and services.

I'll get the source later. But to be a Primary Dealer you have to participate in every auction by mandate. That is why they are the "Primary" Dealers. And all Primary Dealers are banks.

There is a net increase in assets. You have to view the economy through balance sheets of assets. Just focusing on money does not make this come to a reality.

A loan is an asset to a bank. A treasury is an asset to the private sector. HUGE difference.

Correct

What??? Of course it does

There is an increase in deposits because of Govt spending. If that money comes back and purchases the debt from the bank, there is a decrease in deposits, giving the banks more excess reserves to leverage for lending.

It does not matter accounting wise. The point accounting-wise is that we first must receive an increase in our deposits before we can purchase the debt from the banks. The banks are the ones FUNDING the Govt. We are taking this new money and purchasing the debt. It is an investment to us. And accounting-wise that is all that matters. The private sector now has a new asset.

It is not only bank lending that increases deposits. Govt spending also increases deposits.

But you have a new asset.

We are getting off tangent here. Now I don't even know what your point is. My point is the funds the Govt uses primarily to credit the nonbank publics accounts come from the banking system in the form of a loan. Therefore the nonbank public does not "fund" the Govt.

The fact that they use the new deposits to purchase Govt debt from the secondary market means nothing except we have people investing their new deposits. You have to understand that this whole basis is premised on Govt spending money. Deficit spending and "borrowing" is what creates the new deposits in the economy... it create MORE money.

 

And they receive in asset in return in which the Govt has a liability to increase their deposits in the future. But regardless this does not have anything different from what I claimed in the OP. I have gone over this process already... and I do not get what point you are making.

Not always, Dealers hold on to plenty of treasuries. In fact the Fed just purchased $800 billion from the treasuries. So that is always a fact. The fact is the Govt creates deposits from bank money, with out taking deposits from the nonbank public.

It's about the 2nd most liquid asset in America outside of money.

Yes, but the debt lead to an increase in deposits, which gave the nonbank public the ability to buy this debt. Accounting-wise the Govt must go in to debt in order for us to have the money in which to pay for said debt. That is the whole point. Everything is dependent on the Govt going in to debt.

Because the Govt uses the same process when the debt comes due. They don't need to take my deposit to increase your deposit when your debt matures. They go through the same process of taking it from the banks. The point I'm trying to make here is that the nonbank public does not need to fund the Govt and the Govt does not take from the nonbank public (unless they want to) to increase our deposits.

They don't lend reserves. They leverage reserves. The point is the Fed's do not create deposits in the system. They simply control the amount of money the banks can create through loans. I have said this from the very beginning. It still comes down to how much the Govt spends.

We are talking about how money is created through debt. So you also have to understand the role the Govt debt plays in the money creation process.

The point is that Govt spending has to increase deposits before the nonbank public can "fund" the Govt. The people need Government spending before they can pay their taxes or fund the Govt... it is all dependent on Govt spending and those assets the private sector accumulates from the spending.

This is just semantics. The Govt is not dependent on the Fed making reserves. The Fed makes reserves because of the Govt spending. Like I showed in the OP, the Govt creating accounts is just numbers in a computer. The Fed has to make this spending in to usable cash. The Fed does not tell the Govt how much they can spend. If the Govt wanted to spend more than the available reserves, then the Fed would just purchase the debt instantly from the Primary Dealers creating more reserves in the system.

The Govt depends on nobody. The tax payers depend on the Govt to give them the money in which they can pay their taxes and purchase Govt debt.

That is the entire point of this whole OP... is that the Govt must go in to debt before the money creation process can happen.

 

What do you mean "The bank will just have to acquire the reserves from the interbank market afterward and will be in deficiency with the Fed Bank."

You're position is that the Govt just gives out Treasuries for nothing?

That wouldn't be a loan, that would be a gift.

Quite true. Once again, read MMM step 6. If the bank has no reserves, who does it transfer reserves to pay the check?

When the sell the Treasury to a nonbank, the reserves are transferred to the bank.

Then say reserves.

See link showing some aren't banks.

But the fact that the Fed buys and sells through brokers is irrelevant. What is relevant is who ultimately holds the Treasury, as I've shown.

And a net increase in liabilities. Acknowledged.

A loan is an asset to anyone who makes it, bank or not. No difference. If I loan you $100, I have an asset, just like the bank does. If a bank has a Treasury, it is an asset, just as if I held it.

Same thing when I loan to the Govt by buying a Treasury.

No difference at all.

In both cases, there has been a decrease of deposits by the lender and an increase by the borrower's payee.

A decrease in deposits in the bank decreases excess reserves. As we've agreed, required reserves are a percentage of deposits and excess reserves is the difference.

No increase in deposits is necessary. If I have $1000 in my deposit account, I can buy a $1000 Govt note. I don't have to increase my deposit account first.

The banks are not funding the Govt, because they sell the debt. To the extent banks act as brokers, they just buy and sell.

But unlike a bank, deposits created by Govt spending are offset by deposits decreased by taxes and lending to the Govt.

And a decrease in deposits, offsetting the increase in deposits by the Govt spending.

The point is that we are now talking macro economics, and you are trying to focus on a individual transaction.

The point is, in the macro view, Govt spending does not increase deposits because any increase in deposits is offset by decrease in deposits from paying taxes and buying Govt debt.

I'm not sure what you mean by "new deposits to purchase Govt debt from the secondary market".

When someone buys a Treasury from a Dealer they are not using new deposits.

What we are getting to is an understanding.

Govt borrowing does not create new deposits in the economy, it does not create more money, because when a nonbank buys that Treasury, deposits go down, not up.

 

And there is an offsetting liability which decreases deposits in the future when people pay taxes.

The point I am making is that Govt spending doesn't increase deposits because such deposits created are offset by a decrease in deposits to pay taxes or to pay for the debt the Govt issues.

Dealers don't hold them. They resell them. That what brokers do. Same thing as dealers on the NYSE.

A note, whether Govt or commercial, is a promise to pay in the future. There are markets that trade on them but they are discounted based upon interest rates. You cannot immediately redeem a $10,000 note due in 10 years for face value in cash.

They are not money.

And for every entity to whom it is an asset, there is another entity to whom it is a liability.

If an only if the debt is owed to a bank. Otherwise note.

If the debt is between nonbank entities, there is no increase in deposits, as we agreed before with the $100 loan from me to you.

In the case of Govt debt, the vast bulk of it is not owed to banks. And therefore does not increase deposits.

If the Govt redeems the debt, it needs tax revenue to pay for it, which decreases deposits.

If the Govt rolls the debt over, there is no change in deposits.

Banks (that are Dealers) act as brokers but not primary debt holders to the Govt.

Reserves are transferred to pay for the loan when it is applied.

Once again, see step 6 MMM.

And that is exactly what we are discussing to understand.

The point is that increases in deposits by Govt spending are offset by decreases in deposits to pay taxes and to buy Govt debt.

So there is no net increase in deposits.

No, the Fed makes or eliminates reserves based on its determination of money supply policy thru the FOMC.

See the 17 cites in the other thread.

The Govt Deposit Account is the equivalent of reserves, as you acknolwedged. When the Govt spends, amounts in the Govt Deposit Account are expended and changed back into bank reserves credited the payee's account.

Just like when any other check is issued.

I don't get my money to pay taxes from the Govt. So that is false.

[qutoe]
That is the entire point of this whole OP... is that the Govt must go in to debt before the money creation process can happen.[/QUOTE]

That is not true, because the Fed could buy other assets.

But it is certainly not true to the tune of $14 trillion dollars. The Fed only holds about $1.5 trillion.

 

I wasn't speaking about the transaction with the Govt, I was speaking about deposits being used to write checks on by the nonbank public.

The reserve isn't the money. The deposit is the money when we use our deposits. They don't need reserves in order to reduce my deposit in the computer system. They reduce it and then go track down reserves in the interbank market. The interbank market is specifically there to curb these reserve deficiencies.

What?

NO IT IS NOT!! The whole point of the OP is that the nonbank public needs the deposit from the Govt first before they can pay their taxes and pay for the debt on the secondary market. It is VERY RELEVANT on who purchases Govt debt directly from the Govt.

Yes, but a bank also has a liability!! The private sector does not have a liability for purchasing Govt debt. It is just an asset on the private sector books.

Yes, but the nonbank public purchases 1% of treasuries issued directly by the Govt. So this really isn't the case and accounting-wise really does not matter in the long run

For the banking system as a whole they lose a deposit which increases their excess reserves. This is when you use your deposit money to purchase a treasury off the banks.

Accounting-wise... it has nothing to do with what you just said. The point is someone else has an increase of $1000 in their account.

But the DEPOSIT has to come first before the nonbank public can purchase the debt from the banks. That is the entire purpose. The fact that you are dwelling on who holds the note last is meaningless in this discussion. It is about who funds the Govt so that the Govt can credit our accounts. We NEED money first before we have the money in which to purchase Govt debt

We already clarified this. We are talking about deposits created by deficit spending in which the Govt has to issue debt. The tax issue is a wash on deposits and we already know that.

Lol, we are going backwards. Why are you talking about taxes again. We are talking about Govt debt. The point is that the nonbank public does not fund the Govt to credit our accounts. The fact that we purchase the debt off the secondary market does not affect the accounting that happens when banks fund the Govt.

Accounting wise... come on!!!

When the NONBANK buys it from the secondary market. We are definitely not coming to an understanding because you are not even in the same ball park on the significance of the banks funding the Govt in order for the Govt to credit our deposits.

Accounting-wise the deposits must come first before we have the money to purchase the Govt debt.

It is clearly laid out in the OP. That is exactly how the accounting goes when the Govt issues debt. But the point is that the Govt must spend money first before we have the money in which to pay our taxes or purchase Govt debt. It's the chicken or the egg.

 

They resell them because now the nonbank public has the money to purchase them. The Primary Dealers would not be needed if the public has the money to fund the Govt. The nonbank public needs money first before it can purchase the debt the money was created from.

The point is none of this puts a restraint on how much the Govt can spend. The Govt debt simply becomes an asset for the nonbank public to have as an investment.

It does increase deposits. The fact that the Fed purchased $800 billion off them just a year ago means there were $800 billion more deposits. Your point that we purchase the debt off the secondary market has no bearing on the OP. In fact it is strictly mentioned in the OP how that is the only way the nonbank public can purchase debt on the secondary market.

They act as an intermediary so that the Govt can spend whatever it wants with out relying on the nonbank public to fund them. The Primary Dealers are nothing more than Govt puppets that spend Govt money.

Sure there is, every time a Primary Dealer purchases a treasury (over 70% of them), a deposit is increased. The fact that the treasury is purchased on the secondary market a deposit is reduced does not change the fact that a deposit was created before a deposit was destroyed.

I agree

And? You are acting as if this is a restraint on the Govt. It is not, it is a result of Govt spending. The more Govt spends the more reserves are going to have to be created.

Accounting-wise, yes you do. Showed in perfect representation by the OP

The Fed is extremely limited in what it can buy. All they can do is create reserves in the banking system. The nonbank public never gets an increase in their deposits because of Fed's monetary policy decisions. The increase comes from the banking system creating more loans.

 

Once again. Let's look at this from a macro accounting position.

Banking System
A | L
Ex Reserves $900 | Deposits $1000
Req Reserves $100

Banking System Purchases a Treasury for $500
A | L
Ex Reserves $850 | Deposits $1000
Req Reserves $150 | Treasury Deposit $500
Treasury $500

Now when the Govt wants to spend, they take their $500 from the bank and an equivalent amount of reserves. So the system looks like

Bank System after Govt takes $500 out
A | L
Ex Reserves $400 | Deposits $1000
Req Reserves $100
Treasury $500

So now the Govt spends that $500 and credits your account.

Bank System after Govt credits your account by $500
A | L
Ex Reserves $850 | Deposits $1500
Req Reserves $150
Treasury $500

There is $500 more in deposits. Accounting-wise the money has to be deposited in our accounts first before we can go and purchase debt on the secondary market.

So now the only thing that happens when you purchase debt is you change the reserve ratio from the banking system by reducing deposits. Now the banks can lend more since you sacrificed $500 out of the money supply.

Please tell me where you do not agree with anything I just wrote?

 

The reserves are the money used when a check is written.

See MMM step 6 proving it.

I'm not sure what you mean by "track down reserves in the interbank market" but I suppose you mean that a bank can usually obtain short term loans from other banks (fed funds). The bank must transfer reserves to fund the check. If that results in a short fall in its required reserves, it might obtain a short term loan to cover it.

The key point is that they need the reserves to pay the check. Obtaining a short term loan is fine and dandy, if the bank is health and qualifies for the loan.

But if there has been a run on the bank, and it cannot obtain a loan, then it cannot obtain reserves.

Then you can have a million dollars in your deposit account and write a million dollar check, and it will bounce, because your bank has no reserves to transfer.

It is the transfer of reserves that pays the check.

If I buy a Treasury from a Dealer, I write the dealer a check for the amount of the note. Reserves are transferred from my bank to the Dealer, and to the Govt (if the Govt hasn't already been paid.

You OP is not a authoritarian source, but your view of how it works.

How it really works is what we are getting to.

When I refer to your OP you point out its a hypothetical. I agree. But if you want to go back to your OP, they error in it is that a bank can buy a bond from the Govt when it doesn't have money to pay for it to begin with.

The fact that a Dealer buys the note and then resells it is immaterial because the Dealer doesn't hold the debt ultimately.

Ultimately, you have transfer of reserves and decrease of deposits from the ultimate buyer of the Note to the Govt. The Govt spends those reserves, increasing the deposit account of the payee.

You have no net change in deposits, and no net change in reserves, and no net change in the money supply.

All you have is an increase in notes payable and notes receivable.

Exactly!

The bank has a liability in the form of deposits that are not decreased when it loans money. Which is why bank lending, and only bank lending, increases deposits.

Which is also why if a nonbank ultimately holds the Govt debt, there is no increase in deposits.

But the nonbank public ends up holdin 99% of the treasuries. That that really is the case and accounting wise explains why Govt spending does not increase the money supply.

A decrease in deposits decreases excess liabilities.

E.g:

Bank A|L

9k Excess reserves | 10k deposits.
1k Required reserves

A depositor buys a $5000 T-bill and writes a check.

4.5k Excess reserves | 5 k deposits
.5k Required reserves

Which is offset by the $1000 decrease in my deposit. No change in deposits.

Why do you say that? The nonbank public has trillions in deposits that it can use to purchase the debts.

The Govt cannot spend until it has reserves in its Deposit Account, so it has to get the reserves first.

Otherwise it would have negative balances in its deposit account.

That's what I'm talking about. The lending side is a wash just the same as the tax side, the only difference being is that there are notes receivable and notes payable associated with the debt.

Taxes are part of the source of Govt reserves that it spends.

The nonbank public is the primary source of funding the Govt. 99% of debt held by the public is held by the nonbank public. They provide the funds the Govt uses to spend.

Accounting wise thru the system, which is why Govt operations do not change the money supply.

OK, lets clarify it. We have a disagreement on exactly how Primary Dealers work, but it doesn't matter, so I'll use your understanding.

Govt issues floats a $10k, bond.

The Primary Dealer buys the bond. Now at this point, the Primary Dealer either 1) transfers reserves to the Govt Treasury Account or 2) doesn't. You say the latter. But if that is true,

Then the Dealer sells the bond on the open market.

I buy the bond. I write a check or wire $10k reserves to the Dealer.

Then the Dealer either 1) keeps the $10k because it already paid the Govt, or 2) transfers the $10k to the Govt's Treasury Account.

So where are we?

My bank is down $10k in reserves and deposits.

I am down $10 in my deposit account.

The Dealer is neutral. He was either reimbursed the $10k he transferred to the Govt, or simply passed through the $10k I paid him. He gets a fee for his services.

The Govt's Treasury Account is up $10k.

so far so good? Now the Govt spends $10k to fix a road. The Govt transfers $10k out of its Treasury account to the Builder, who deposits it in his bank account.

So at the end of the day, where are we?

The $10k decrease in my deposit account is offset by the $10k increase in the Builder's deposit account. No change in deposits.

My bank is down $10k in reserves, but the Builder's bank is up $10k in reserves. No change in reserves.

The Dealer is neutral. He just got a fee.

So at the end of the day, there has been no change in deposits and no change in reserves as a result of the Govt's operations from deficit spending.

 

Reserves must come first. You cannot have a deposit unless you have reserves.

the OP is wrong. And I've just shown you how we don't have to have the Govt spend money first. We must have reserves first. You are putting the chicken before the egg.

 

Primary dealers are used because then the Fed doesn't have to deal with entites that don't have the money or will make a steady market or try to find buyers or sellers. The Dealers are brokers who do that function.

When the resell them it washes out any deposits created by Govt spending.

The ultimate restraint is that at some point the public becomes concerned about whether the Govt will pay its debt without defaulting or (more likely) monetarizing the debt and causing inflation. In either case, the public will start to demand higher interest. Plus the Govt has to pay interest on the debt. Plus it can squeeze the availability of credit to businesses.

When the Fed purchases debt, in creases the reserve money supply including deposits. If the banks lend the money, far more than $800 billion in deposits can be created thru the money multiplier.

What has bearing on your OP was your erroneous assumption that a bank can pay for a Treasury when it has no money.

The Dealers set the interest rates by bidding on the Treasuries. If the Dealers cannot resell on the open market, they will bid upon the interest rates on the Treasuries to make them more attractive. That however increases the cost of the debt to the Govt.

Let's get clear, we may be talking about two different things. Are you talking about a PD buying a treasury from the Fed or from the Govt?

When a treasury is purchased from the Govt and ends up held by a nonbank, there is ultimate decrease in deposits (excluding the Treasury Account at the Fed) from the purchase who ultimately bought the note.

Back up back up. I thought we agreed that Govt spending does not create reserves. You've been saying Govt spending creates deposits all along and now you say reserves.

Did you mean deposits?

Let's get this straight!

The OP is wrong because the bank doesn't have reserves to pay the Govt for the note.

Creating reserves is how the entire money supply is regulated. What do you mean by limited? Limited by what?

When a bank gets reserves from the Fed, either by borrowing or the result of someone depositing the proceeds of a sale of an asset (like a Treasury) to the Fed, that increases deposits and reserves.

Suppose I have a $10k T-Bill and $5k in my bank account.

My bank (which has previously lent out its execess reserves) has this:

Bank A|L
Notes receivables 9k | Deposits $10k
Required reserves 1k

Now I sell my $10k T-Bill to the Fed thru a Dealer and I get $10k which I put in my bank.

Now my bank has this:

Bank A|L
Note Rec. 9k | Deposits $20k
Required res. 2k
Excess res. 9k

Now my bank has the capacity to go out and create another 9k in loans, which are multiplied thru the system creating more deposits.

 

I don't believe the Bank can buy a Govt Treasury and not pay for it. But it matters not. Assume its a Dealer and the dealer resells the Treasury to Joe Nonbank as the do with 99% of them.

Then what does the bank look like?

A | L
Ex Reserves $450 | Deposits $500
Req Reserves $50 |

So now the Govt spends that $500 and credits your account.

Bank System after Govt credits your account by $500

A | L
Ex Reserves $900 | Deposits $1000
Req Reserves $100

Right back where we started!

You are missing the fact the the Dealers sell the Treasuries to the nonbank public.

 

But the reserves DON'T have to be there. It is simply for accounting purposes. If a bank has $0 in reserves, you can still write a check, and you can still use your deposit. The reserves is simply an interbank function... it has nothing to do with your check being able to be cashed in another bank.

No, they need reserves because the Fed says they need reserves. This is two separate arguments, one from the banking perspective, one from the nonbank public perspective. When we write checks we are writing them on our deposits and it is simply debits and credits within the banking system. The reserves have nothing to do with these debits and credits. They are acquired and traded after the deposits are changed. Banks do not need reserves in order to transfer money from one deposit to the next.

The example you keep citing is simply the accounting that goes with check writing. In the banking system reserves are transferred from one bank to the next... BUT the public is not dependent on this transfer it is specifically for the banking system.

It can always obtain reserves by either excess reserves in the system or borrowing from the Fed. The Fed is there to make sure any runs on banks are covered. If there was a nationwide run on the banking system, they would just purchase more debt to create more reserves so more people can cash out their deposits.

False, your check will never bounce because of how much reserves a bank has.

There is no ultimately about it. Ultimately the Govt credits your deposit accounts before any debit is performed. So ultimately we receive the money before we give it back. That is the entire point.

When the Govt credits your bank account, they are increasing deposits. That has nothing to do with bank lending.

It doesn't matter, the nonbank public only purchases 1% of treasuries at auction. They do not fund the Govt. They receive the money before they purchase the debt

Which came from previous Govt spending. You have to view this from an accounting angle. Assets and Liabilities is how the system works. When I say the Govt must first spend before you can purchase Treasury debt I mean it in an accounting sense. Of course you can use previous money to purchase new debt, but accounting-wise it is still the exact same. The private sector is left with a new asset.

The fact that policy says something doesn't mean that is the reality. The Fed, Primary Dealers, and Treasury work together every day to make sure the Govt can spend whenever it wants to spend. It is one cohesive unit. The Govt can never run out of reserves.

False, we have already gone through it... the nonbank public funds 1% of treasuries auctioned off.

Sure it does, they increase deposits which increases the money supply. They do not increase the base money supply.

Your making all sorts of assumptions based on the fact that the nonbank public ends up purchasing the treasuries on the secondary market. The point is that the Govt gets funded by the banking system, not by the nonbank public.

The nonbank public receives an increase in deposits before it decreases it's deposits to purchase the security.

I have said this from the very beginning. And I have laid it out in clear detail. You are skipping over the fact that the Govt increases our deposits first. You are skipping over the fact that Primary Dealers do hold on to securities... given the fact that just 1 year ago the Fed purchased over $800 billion from them. If you take away foreign ownership of treasuries that is over 10% of the available treasuries on the market. That is HUGE and it completely debunks your statement that ultimately it is a wash. Because it is not ultimately a wash.

Ultimately the nonbank public can or can not purchase securities on the secondary market. They can choose not to invest in Govt debt, yet the Govt can still spend whatever it wants.

Ultimately all money creation is dependent on the Govt going in to debt.

 

They DON'T HAVE TO sell them to the secondary market. They can hold on to them, the Fed's can buy them from them, etc. The fact is our deposits increase before they decrease. It is basic mathematics and accounting and it's completely dependent on the Govt going in to debt.

The fact that you are not realizing that it is the asset that is created out of this process is where you are misunderstanding how money is created.

That treasury floating around the economy is attached to Govt spending... no matter who buys it, be the Fed, foreign central banks, or the nonbank public, there was a deposit that increased because of that debt.

And it's that debt alone that the Fed uses and the Govt uses to increase the amount of money in our economy.

Our entire monetary system is based on Government going in to debt.

 

You can not have reserves unless you have a deposit. The chicken and the egg approach. You are getting hung up on the fact that hypothetically if you started out that banks couldn't spend money because there was no reserves.

But hypothetically there couldn't be reserves unless their was deposits.

But in reality the system already had reserves and deposits, so the hypothetical didn't have to happen. It doesn't mean that the system doesn't work exactly like that.

But you need the Govt to spend money first before you can have reserves.

You are putting the egg before the chicken.

The Fed does not make money so that the Govt can spend. The Fed turns Govt spending in to usable money. That is it... the Fed is only limited to how much the Govt has spent. Everything is determined on the Govt spending money before anything else in the system can happen.

I have shown this over and over again. I mean look at all these posts we've made, now put two and two together. Where else would money come from? The Fed can not credit your account, it can not credit my account. The Fed cannot create deposits. Only the bank can create deposits through loans and only the Govt can create deposits through spending. Those are the only two ways.

The Fed comes in and makes Govt spending usable in the real economy, not the other way around.

 

But it creates the very asset that is used to control the money supply

The money is spent before it is used to "fund" the Govt. Treasuries will always be in demand because they will always be paid and there will always be funds to pay them since the treasury created the money in the first place.

NO IT DOESN'T!!!! The Fed does not increase deposits. It increases reserves in which the banks can leverage for more loans/deposits. The Fed can not create deposits... that is essential to understanding this.

Chicken or the egg... take your pick... regardless we get to the same system.

Who cares... this has no relevance to the discussion.

The Govt

I never said there wasn't. But there is a new asset in the system which is the pivotal piece to the puzzle. That debt is what is used to create our money.

I said the more the Govt spends the more "reserves" are going to have to be created. I didn't say the Govt creates reserves. BUT, Govt debt is essential for reserves to be created.

The OP is hypothetical... it still shows exactly how the system works. Just because reserves/deposits were left over from our previous system does not dismiss the fact that the OP is correct.

No it doesn't... it has no bearing on deposits. It only gives the banks reserves... that is it!!!

The Fed does not buy debt from the open market in our system. It buys strictly from the Primary Dealers and only the Primary Dealers. The Fed does not create any deposits.

And even with your example... all the Fed did was still convert Govt debt to usable money, that usable money is still backed by Govt debt and still represented by Govt spending.