For those of you who understand reserve accounting, note that the Fed can’t do what’s called a reserve drain without doing a reserve add. So what does the Fed do on settlement day when Treasury balances increase? It does repos – to add the funds to the banking system that banks then have to buy the Treasury Securities. Otherwise, the funds wouldn’t be there to buy the Treasury securities, and the banks would have overdrafts in their reserve accounts. And what are overdrafts at the Fed? Functionally, an overdraft is a loan from the government. Ergo, one way or another, the funds used to buy the Treasury securities come from the government itself. Because the funds to pay taxes or buy government securities come from government spending, the government is best thought of as spending first, and then collecting taxes or borrowing later.
[Warren Mosler. My emphases.]
A simplification* certainly, nevertheless complicated stuff. Somehow counter-intuitive. A central bank just creates money, from nowhere, because it can. Government sells debt because … more on that below. Money is injected into the system, money with which government debt can be bought so as not to incur the irritation of commercial bank overdrafts of accounts held at the Fed.
Why so complicated? My short answer: banks are profit-making businesses with enormous, centralized power. The commercial bank system is the sole conduit between people and “high powered money” and exists to make money for its owners. Banks are businesses. Banks are therefore usurers ‘corporatized,’ which in effect means institutionalized, which means state-sanctioned. They are also, at some size and in the eyes of the state, too big to fail. They are therefore, ipso facto, part of the state. They are not distinct components of a logically separate ‘private’ sector, somehow at the mercy of government high powered money creation. Indeed, my impression is that central banks exist in part to mask how powerful commercial banks are. Of course economic stability is key, but one can also argue that such stability as is achieved serves commercial banks more than any other sector; it must, after all be stable growth. Economic Growth is systemically yoked to usury and the dynamic of the pyramid scheme, and is the hidden core of our money system.
The Fed can’t drain without first adding: To me, that’s not really a drain. That’s like adding water to a pool in the hope that the pool’s manager will allow you to take it out again in exchange for magically expanding ice cubes with different melting rates.
Repos: adding funds to the banking system, funds which banks then might use to buy government debt—note there are “primary dealers” ‘obliged’ to buy government debt at debt auctions. So why bond auctions at all? Why not just hand over the bonds ‘for free’ and cut out step 1? Because then the money markets would no longer be money markets as we know them. Then the whole thing would be too much of a joke, and a less entertaining one than a game of Monopoly. The following quotes hint at what I mean:
“Efforts to rescue the UK economy were plunged into fresh uncertainty this morning after the government failed to find a buyer for some of its debt, the first such failure in seven years.”
“1.923 BTC X 61.59% Primary Dealer bid = 1.18 BTC (PD), greater than 1.0. Or to put it a different way, but for the primary dealers the bid-to-cover was less than one, meaning that some of the issue would have been left on the table.
“Thats a fail; but for the primary dealers the issue would not have subscribed.
“Primary dealers are required to bid. That's the deal in exchange for their being named as "primary dealers." For this reason short of thermonuclear war you will never see an actual (BTC < 1.0) "fail" on a US Treasury Auction - Treasury has rigged the process so as to insure that cannot be reported.”
“China's finance ministry has failed to sell all 28bn yuan ($4.1bn; £2.55bn) of one-year government bonds it offered at an auction.
“It is the first under-subscribed government bond auction since 2003.”
Quite embarrassing (or at the very least odd) when you ‘give’ the buyers the money with which to buy your product! And I do not believe all of the above is pure, clueless guff from a mainstream media unacquainted with the fine points of MMT. The larger story such stories weave is very important, very powerful, has us in its grip. Ownership of this story, being able to propagate it at will, controlling the paradigm, this is what is at stake here. Who owns the story? The ‘People’ or The ‘Elite’? Does MMT threaten this story, or merely present it from a different angle?
Bond issuance is serious stuff, no matter how ‘effortlessly’ central banks can change numbers in commercial bank accounts. Mosler’s analogy of a football stadium able to display points on a scoreboard without having to borrow them, is misleading; there are very clear rules for the assignment of points dependent on the game of football afoot. As I understand it, the sale of bonds is, from one perspective, a way of measuring the market’s opinion of that country’s growth prospects. From another it is a large, international process which boils down to control of the money system by the owners of money, that is control of the flow of funds generated by usury. Thus if governments were to side-step bond issuance entirely, directly pump the economy with high powered money as they saw fit, that would be printing, pure and simple. That would be government determination of how much money the economy needs, not market. It would be the government ignoring the market. But the market’s opinion must hold, because the Free Market Myth says, ‘Invisible Hand Knows Best!’; that government interference in, or ignoring of the market produces negative outcomes. To be wise, to be in tune with what economics and history have proven time and again, governments should yield to market forces, just as we must all yield to gravity. If we ignore this universal truth, hyperinflation will (eventually) occur (which, by uncanny coincidence, happens to hurt the owners of money more than borrowers).
High powered money is not ‘given’ with the explicit instruction to buy X amount of government debt with it (of course, not only banks buy bonds, but the money to do so does come from their ‘reserves’). Bond auctions must be (more or less) genuine auctions. There is a choice to hold onto the injected cash or exchange it for something less liquid. The stated reason for the injection of high powered money (HPM) is to keep reserves up, to prevent commercial bank overdrafts at the central bank. That annoyance would mean some commercial banks owed the government money, whereas bond ownership means the government owes banks money. Much nicer. What the commercial banks freely decide to do with those freshly injected reserves is their business (unless they happen to be “primary dealers”). As such, “high powered money” hardly has the descriptive ring of truth to it! Its existence and creation is more the legal requirement of a system designed to keep money fruitful and potent, in and of itself, I believe as a centralized tool of control. HPM serves to enable usury, even though usury does not require it (arguments of stability to one side); Canada has a zero reserve system. In the end it is usury which must survive. This system works in the interests of the owners of wealth, who get to make judgments, and profit, on the ever-shifting attractiveness of various currencies, regardless of whether it was cynically designed to do so; regardless, too, of whether the ‘elites’ really are elite and thus ‘deserve’ to protect their positions via such mechanisms.
So, why do governments sell debt? Because of usury generally, because the rich and powerful want to carry on making more money from their money, indefinitely. The system works for them first, for the rest second, and by coincidence. ‘Trickle down’ is a sop. Even the twin responsibilities of ensuring the ‘correct’ quantity of HPM and preventing too high inflation, the main duties of a central bank, at the deepest level, work to protect (stabilize) the interest-based money system. Who in the mainstream talks warmly of zero or negative growth GDP? Social dividend? Demurrage? As such this system is a ponzi scheme for the ‘elites’ and will completely collapse when it becomes apparent to the majority that growth is over. The current system cannot cope with steady state economics. Private sector credit money may not, effectively and in toto, net to zero because its absence would be the destruction of at least 90% of the effective money out there. “Reserves are unchanged by the loan transactions. But the deposit credits constitute new additions to the total deposits of the banking system.” (From “Modern Money Mechanics” (my emphasis).) Were credit-money-originated claims on HPM ineffective or irrelevant or impotent, somehow not “legal tender”, somehow ‘less’ than HPM, the system simply would not work. “Nets to zero” is neither here nor there, is a red herring. Money promised to function as money must do so. And why do we have money? To assist the economy. Why must the economy be assisted? Because the Perpetual Growth economy, in its current form, sustains elitism.
Commercial bank overdrafts at the Fed: Loans from the government. If a commercial bank is net negative in its reserves, the government is obliged to ride to its rescue. How will a commercial bank repay that money? After all, it can’t create HPM! My guess would be to ‘win’ more reserves from other banks via ‘wise’ extention of credit, but, in truth, I don’t know, and haven’t seen the answer in Mosler’s book. Interest earned on loans does not alter the amount of reserves generally, and is furthermore bank earnings; that is, bank earnings pay bank operating costs, wages, profits to shareholders, etc., so are distributed back out into other accounts in the system as already existing reserves. One bank’s owing of reserves to the Fed is the system ‘bleeding’ HPM generally speaking. Think of all banks as one, as compartments containing the total of HMP in existence. Any reduction of the amount of HPM in the system is potentially dangerous, because credit money is the economy's lifeblood.
As an aside, this is good place to remind ourselves that interest is redistribution, not creation. But as that redistribution favours the owners of money (over time), shortfalls occur among the poorer portions of society, which generates a need for more HPM. If the economy is not growing sufficiently quickly, there will be falling demand for new loans, credit-money claims on HPM won’t multiply, and defaults (credit-money destruction prior to banks earning a profit) will increase. The amount of (effective) money in the economy shrinks and there is less profit to be earned from interest. If too many people and businesses are too indebted; as, say, oil reserves become increasingly more costly to extract, in energy terms; if also consumerism is faltering, its charisma wearing thin, even new injections of HPM will make no difference. All more HPM can do is increase the ratio of HPM to credit-money, e.g., raise reserves and lower the risk of a bank run (depending on many other factors). But the point is not the amount of HPM (which is almost like dead money), but the rate of growth of the economy as it relates to potential credit-money creation and profits via usury.
Borrowing later: Government creates the money it borrows. It gives the system the money it later borrows at interest. That’s weird and telling, in my opinion.
In brief, government places money as reserves into commercial bank reserve accounts, with which government debt can be ‘purchased.’ “Otherwise, the funds wouldn’t be there to buy the Treasury securities, and the banks would have overdrafts in their reserve accounts.” What a line! Banks with overdrafts mean banks with negative reserves. Counterproductive. Must be immediately rectified by the Fed.
Government sells bonds and other forms of debt as one way of taking HPM back out of those accounts, lowering (for a while) the amount ‘in existence.’ Each debt promises to pay back that amount of HPM to the bearer plus some interest. And then one day government pays out on those bonds, whereupon more HPM enters the system.
The HPM, which must be exchanged for these transactions to occur, is created at need by the government and only by the government. Funny money? What is that money backed by? Whence does its value come? Some say tax and the solvency of the people. I say the value of this money comes from growth of economic activity, or, ongoing sale and purchase of ever increasing amounts of goods and services. Imagine an economy with only taxation. Government gives you money, then taxes it away again. The evidence that growth backs money is the maths of usury (P < P+I), the way the system invariably collapses when it is not growing (recessions and depressions are Not Good), and that inflation drains value or wealth from money.
So, why buy government debt? You ‘exchange’ some of your high powered money for debt because you want the amount you hold of that currency to grow faster (or more securely) than it otherwise could in some savings account. You want more of that currency at some later stage. Why more of that particular currency? The only reason I can think of is because you expect it to be stronger than other currencies, to retain better its purchasing power relative to others. Or some other reason to do with increasing your wealth. You would not buy government debt expecting to lose money (except as a primary dealer, who’d be bailed out at need anyway).
The system is about getting money-richer, money being sticky abstractions of ‘measured’ wealth. Money working for you. Investing so as to maximize profit from money-ownership; a wise mix of risky and stable in your portfolio. Government debt is sound. They can always pay. The only question is, what is the value of this currency relative to others? What does a bond or other government debt offer relative to a commercial bank savings account, or some stock, or gold, or oil? And growth in the economy must be occuring for growth of the money supply not to be inflationary. Growth must also be happening for there to be more and more people wanting to take out loans, earnings from which pay for the interest owed by banks to the owners of money.
The system looks like, as others have said, a government backed counterfeiting cartel. Its centre is the credit money system, for which the central bank acts as a kind of hidden guarantor, a rock of stability. HPM is an enabler of the commercial bank activity. In the end, it does not really matter whether we have 100% reserves or 0%; money means, systemically, that we all need money of some accepted kind to survive. When you need money to survive and there is not enough for everyone ‘out there’ (how could there possibly be enough?), some will have to borrow. Those in a position to ‘help’ financially people in need survive are systemically constrained to abuse that power, because the underlying premise of the entire system is differential advantage, perpetual competition, and success as concentration of wealth and power to increasingly few. (The appendix in Eisenstein’s “Sacred Economics” is very helpful on this point.)
Where does money disappear to? To the Great Nowhere of the Fed via taxes and government ‘debt.’ What about interbank lending; how did it dry up in the second half of 2008? If we are to understand HPM as a pool kinda sorta equally distributed (dynamically) among accounts held by commercial banks at the Fed, and if only the Fed can create/destroy it, how did it disappear to critically low levels? How was there a ‘shortage’ of it? Derivatives and sub-prime. ‘Creative’ forms of debt. The claims on HPM were excessively above ‘required’ reserve ratios and were cratering bank balance sheets. It’s not that HPM disappeared, it’s that there quickly became too little relative to the multiple and exotic claims on it. The HPM/Debt cocktail was way too thin (though HPM is also debt-bound due to government selling debt on the money markets). The bursting of the real estate bubble had an explosive impact on bank balance sheets, such that no bank trusted the other. What to do? The system can’t be allowed to fail! The rest, as the saying goes, is history. And the times are getting interestinger!
Some graphics inspired by Modern Money Mechanics
* “Currency held in bank vaults may be counted as legal reserves as well as deposits (reserve balances) at the Federal Reserve Banks. Both are equally acceptable in satisfaction of reserve requirements.” And: “Part of an individual bank’s reserve account may represent its reserve balance used to meet its reserve requirements while another part may be its required clearing balance on which earnings credits are generated to pay for Federal Reserve Bank services.” (From “Modern Money Mechanics”.) There are fine grades of difference in the role played by high powered money as it resides in different places, as well as what reserves really are, and not all of it is customer owned, even though there are—by virtue of the nature of fractional reserve banking itself—multiple valid claims on that ‘real’ money. As to ‘real’, in the end, the validity of any money, whether high powered or otherwise, rests on faith: “What, then, makes these instruments – checks, paper money, and coins – acceptable at face value in payment of all debts and for other monetary uses? Mainly, it is the confidence people have that they will be able to exchange such money for other financial assets and for real goods and services whenever they choose to do so.” (“Modern Money Mechanics”) I can only conclude that this complexity serves to generate a powerful and unconscious sense of wow! in the observer, to foster trust in the competence of the experts who designed and remain in tight control of such an amazing system. Seriously. This is an amazing system. The smarts involved in building and maintaining it are not to be underestimated. And, perhaps most importantly of all, it is a pseudo-solid chimera that can take almost any shape yet still be exactly what it is; wealth-mining machinery of exquisite design. After centuries in existence, we are still debating how it 'really' works. That says something.