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The U.S. "National Debt" explained, MMT-style

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The "National Debt" is not a measure of debt, but a measure of saved dollars.

Step One: forget everything you thought you knew about economics.

Most of the conventional wisdom is bunk. Flush your old college Econ 101 course out of your memory and start with a clean slate. If what you think you know doesn't stand up to both logic and hard data, it's probably wrong.

Where dollars come from

The U.S. dollar is a fiat currency. Dollars can only be created by the U.S. government (for simplicity, it helps to think of the Fed, the Treasury, and the government as a single entity, as they work in concert). Dollars are introduced into the economy by deficit spending. (Where else are they going to come from?)

Where dollars go

When large amounts of dollars are amassed, the people, banks, businesses, or countries that hold them often choose to "invest" those dollars in federal government bonds, as they earn a bit of interest, and are basically non-risk places to park money. This is our "National Debt." As you might have already noticed, it's not really debt at all.

Here is the best analogy I have heard to illustrate this... You have $12,000 in a non-interest-bearing checking account at your bank. You only need $2000 available for checking, so you put $10,000 of your money in a Certificate of Deposit account at the same bank. The bank marks down your checking account by $10K, and marks up your CD/savings account by $10K. When it matures, the bank marks your CD account down by $10,000 and marks your checking account up by, say, $10,050. You were always in the same financial position - you had $12,000 (now, a bit more). And the bank was always in the same position as well. Nobody ever says that the bank is "in debt" for $10,000 just because you moved money from your checking account into a savings account. Saying that the U.S. government is "in debt" because people have exchanged dollars for government bonds is just as misleading. Government bonds are basically dollar equivalents - you can easily trade them for dollars, or vice versa. And the government creates them both from thin air.

The "National Debt" is not a measure of debt, but a measure of saved dollars. And since that pile of saved dollars never gets any smaller, you can consider those dollars to be "retired." Government bonds, in a net sense, don't ever get cashed in and spent (although they could). They just sit there, unused, and once in a while a small bit of interest is added to the pile. And that pile has no discernable effect on the economy.

America is the richest country in the world. We are not in debt up to our ears. That should just be common sense.

Then why does everybody call it the National Debt?

Because those people don't know what they are talking about. But realistically, it's an arcane subject, and not many people are interested in learning the details, so it's hard to blame people for simply parroting what they have heard over and over. Politicians have no such excuse - anybody that gets to vote on the federal budget should know how money works.

At best, those people are living in the past. Back in the gold standard days, the creation of dollars was restricted by our gold holdings. When the government wanted to create more dollars than we could back with gold, they actually did borrow in the form of bonds. Happily, those days are over, and we are no longer restricted by some amount of a certain shiny ore randomly chosen to represent value.

The government is still required by law to issue bonds in the same amount as the federal deficit. This law is a holdover from the gold standard days. Now, those bonds are used to control the interbank lending rate. By controlling the sale of these bonds (and buying them at auction when necessary), the government can keep the interest rate where they want it.

What about banks? Don't they create money?

Banks can only create credit. Every dollar loaned out by a bank comes with an attached liability. A bank can lend you $1000, but that does not make you any richer, as you are now in debt for the same amount. And the bank is not any poorer, because (assuming you pay them back) they are owed $1000 (plus interest). No net dollars created there. Also, you may notice that your dollars don't bear the name of Wells Fargo or Chase Bank. ;)

So, with all of these new dollars, how are they holding their value?

The value of dollars is backed up by our economy's productive capacity. As long as we don't create so many dollars that we can't keep up with the demand they create, inflation should not be a problem.

Here's another analogy: A bakery, one of many in the city, sells 100 loaves of bread in a typical day. With the bakers and the equipment they have, they are able to crank out 150 loaves/day if the demand is there, but normally they don't run at full capacity. There is no shortage of flour, eggs, milk, energy, etc. - i.e., if they need more flour, they can get it.

If the government decides to distribute some new dollars to the poor (how or why isn't important), more people now have the means to buy bread, and demand goes up to 120 loaves/day. The bakery easily adjusts to the increased demand, buying more supplies and working a bit faster. Since there is no shortage of any ingredients needed to produce bread, the per-loaf price remains the same. (Remember that there are many bakeries in town - if they raised their price for a loaf, plenty of other bakeries would take their customers by keeping their prices low.) This is an example of an economy's productive capacity being able to absorb new dollars without inflationary pressure.

On the other hand, if the government decided to distribute so many new dollars to the poor that the demand for bread rose to 200 loaves/day, the bakery would either have to invest money in their labor and/or equipment to satisfy demand, which takes time, or they would simply raise their prices (as would the other bakeries, assuming they are in similar circumstances). Or, the increased demand for ingredients might lead to a shortage of flour or eggs, which would drive up the per-loaf cost of bread. Now, you have inflation (demand-pull inflation, to be exact). This is an example of an economy's productive capacity being outstripped by demand (too many new dollars created).

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America clearly has plenty of dormant productive capacity. Detroit could certainly produce more cars if there was sufficient demand. We don't suffer from many shortages of anything. So new dollars are welcomed by businesses, and prices remain low. Most, if not all, of our inflation can be blamed on the price of oil, which we have no control over. (That's cost-push inflation.)

When I was introduced to MMT a couple of years ago, it was a revelation. I haven't looked at politics the same way since that time. I encourage you to read up on the subject, and here are a few links to get you started:

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pjmeli on February 27, 2015:

"How do you feel about the assertion that most of the national debt securities are not sold to acquire funds for government operations, i.e. deficit spending"

That's a no-brainer. Congress passed the law requiring bond issuance dollar-for-dollar against deficits on itself…a voluntary constraint that in practice is not a real constraint. Issuing securities against deficit spending was ostensibly because it was believed to be less inflationary than direct printing, empirical evidence has proven that idea to be nonsense.

There is no functional reason to issue bonds…it's a choice. The reasons behind that choice are largely based on self-interest, not arithmetic.

"What about lending money to an external accomplice who then lends the money back to the bank"

The net of each transaction is zero, as is the net of the circular transaction…both sides of a transaction must always be in balance i.e.…no gain. So where would any profit come from?

In general within any closed system there can't be a gain (or a loss), it's not possible. Apparently this idea is so simple it repels the mind judging by the fact that it is violated routinely by innumerable (innumerate?) commentators.

By its nature, every accounting system is closed, meaning it cannot expand itself (grow or contract) without interaction with another (external) system. For a money system, the external system is numbers (from thin air). That's it.

Your own checking account is an example…it doesn't make itself bigger or smaller. That only happens in the event of deposits or withdrawals, both of which originate from an external account.

You should be looking at set theory and the laws of thermodynamics, not differential equations.

stanfrommarietta on February 27, 2015:

Welcome back, Pjmeli. Yes, there are structural constraints imposed externally on banks that constrains their lending only to those with good likelihood of paying back the loan. Borrows also put constraints on the loan in judging what they would be able to pay back.

I just asked that question rhetorically to see if we could agree on how there are still constraints that limit bank lending.

What about lending money to an external accomplice who then lends the money back to the bank. Can the bank use that for its own profits? And suppose the accomplice defaults? (He gets paid off later). Can the bank keep its money from the accomplice. A lot of this can be executed by subterfuge and disguise. Meanwhile the accomplice enters bankruptcy.

Just wondering....

Nevertheless banks now do not have to first see if they have enough deposits to satisfy fractional reserve requirements before making a loan. That is a new position that is emerging among economists. I think we are beginning to see the effects of taking dollars off the gold standard. It means that the bank does not have to draw on its depositors' dollars (backed by gold) to lend something backed by gold. It just needs to make the loan, and the dollars are created automatically in a deposit from which the dollars will be transferred to a checking account or loan account of the borrower.

I believe that the Treasury has unlimited power to issue securities. It does not have unlimited power to spend money acquired in that manner. It can only spend what Congress authorizes.

How do you feel about the assertion that most of the national debt securities are not sold to acquire funds for government operations, i.e. deficit spending. (Treasury does not need to worry about having part of the funds it needs in taxes. It just needs to get funds to cover the deficit.). But most of the securities it sells are like bank CD's. The Fed as Treasury's banker will get the money from the sale of the security and put it in a time-deposit account at the Fed. Because the security is bought at discount, the principal stored in the time deposit account is less than the face value of the security. It is important to realize that the government has not lost record (even if for practical storage purposes it might destroy physical dollars from the investor)

of the time deposit. Then when the security matures, the investor can demand repayment of the principal plus interest equal to the difference between the principal and the face value. The Fed can easily create that out of thin air. Or if the investor goes to the Treasury and demands the cash back, the Treasury I'm certain has access to the time-deposit account and can return the principal from that and add interest that the Treasury had created by issuing securities and selling them

to acquire money for a slush fund used to pay interest. The Treasury will then simply roll-over those securities forever by swapping new securities for the old. The Fed has unlimited power to create and issue securities.

And while the Treasury never says so, the reason the Treasury issues the securities for investors is to drain their money out of circulation into the time-deposit accounts, so that the government has more flexibility to concentrate on projects

requiring deficit spending, that otherwise would be inflationary if the investors dollars were circulating in our economy buying goods, real estate, and services along with the deficit spending dollars.

Please be my guest at my own hubpage on the hydrology of money flows or MMT and how do we fill the pool without overflowing. I even discuss a differential equation, which I

don't need to solve (fortunately because I know very little about differential equations; if you do, I would welcome a solution). I think everyone who has ever swum in a pool, taken a bath in a tub, or shaved over a basin, has the experience needed to see how to use that equation.

pjmeli on February 25, 2015:

"But it is dawning on me that banks logically have unlimited power to create loans."

Banks have a fiduciary responsibility to make loans only to those that can and will repay them.

Ability to repay is a function of income, and bank loans (spending) are but a fraction of the total spending that generates income.

Ability to service debt is a functional limit on lending. If banks lower their lending standards to the point that delinquencies rise above some acceptable level (above 5% delinquency) , they are breaking their contract with the government.

Which they have done, without consequence, so we can only expect another financial crisis.

Buying anything on credit is effectively a reverse discount…so we have morons shopping at Walmart using credit. Boggles the mind.

"The Treasury can get any amount of money it needs from US banks by issuing securities and selling them to banks"

…and then the Fed (can) exchange reserves for the securities, thus completing the circle, i.e. direct printing of dollars without issuing bonds (to the public). Government holding its own debt is a phantom accounting entry.

The operation of direct monetization was legal until the mid-1980's, when Congress made it illegal, ostensibly because it was never necessary…there has always been more demand for bonds than supply and always will be. The choice comes down to holding dollars, or holding dollars that pay interest. It's a no-brainer.

Even so, under current arrangements there is no functional constraint on government spending other than it isn't possible to buy more than is for sale.

stanfrommarietta on February 25, 2015:

Very good, John. We are on the same page. I had the thought today that if the dollars come in as physical money to pay off a loan, the bank could include this along with other physical cash bought from the Fed with the loan deposit money and paid out to the borrower as cash. It's just madeup money.

But it is dawning on me that banks logically have unlimited power to create loans. But what constrains them from making unlimited size loans?

Do the fractional reserve requirements still constrain loans even if the bank fulfills the requirement after the fact of making the loan by borrowing from other bank reserves or the Fed (as a last resort)?

Do you now see that the Treasury is as powerful as the Fed in creating new money, but does it using the banks' buying its securities and then doing an endless roll-over of the principal while making up the interest in the roll-overs out of thin air by issuing other securities for the interest, etc..

And contrary to Pjmelli's idea that no new money is created, just a shift from banks to Treasury, new money is created--by the banks.

This seems to be the only logical way to run a fiat money system like ours, don't you think. But we don't get clear descriptions of the process. The Treasury can get any amount of money it needs from US banks by issuing securities and selling them to banks. And it doesn't matter what the money is for as long as it is authorized by Congress.

John (author) from Cleveland, OH on February 23, 2015:

First of all, I'm glad to see you finally put all of this into an article. Good job there.

Second, since I wrote this hub, I have been learning more about horizontal money (which I suppose is the natural progression). Yes, banks do create money, by expanding their balance sheets (no deposits or reserves are operationally necessary for this). The bank-created dollars are indistinguishable from government-created dollars.

The loan can be paid back with electronic dollars, in which case there is no "residue," or it can be paid back with banknotes. If it is paid back with electronic dollars (from a different bank), reserves will follow the transfer, as they do when any check moves from one bank to another. If the loan is paid back with banknotes, the bank adds those banknotes to its vault cash (which counts as reserves), and the transfer of reserves happens that way. In the end, the net results are exactly the same. Bank-created dollars are extinguished as the loan is paid off. The banknotes continue to exist, of course - banknotes are bought and sold from the Fed (with electronic reserves) as demand for cash dictates. They are not directly tied to any specific dollars, be they bank-created or government-created; most dollars exist as bank deposits, and you only convert them to banknotes when you want to walk around with cash in your pocket. In doing so, reserves become, in a way, portable. When you take cash out of an ATM, your account is marked down, and bank reserves decrease by the same amount. When that cash gets re-deposited in a bank, they become reserves again.

So to sum up, the only difference between bank-created dollars and government-created dollars is that people and businesses hold liabilities equal to the amount of bank-created dollars in existence, while the government continues to hold the liability on all the dollars it has created (which isn't a big problem, as they don't have to pay themselves back). But the dollars (assets) themselves are fungible - they buy stuff, they can be converted into banknotes, they can pay your tax bill, etc.

stanfrommarietta on February 22, 2015:

John, Pjmelli, and Ken, I hope you are around. I want to pick up on a few threads here. In the interim, I have modified some of my views on how Treasury handles the debt, based on two books by Frank N. Newman, who was a deputy secretary of the Treasury in the Clinton administration, and also a head of a bank in China that he and several other American investors bought when it went bankrupt--I suppose so they could learn how the Chinese banking system works. He says that the way the Treasury deals with securities sold to banks for money to cover deficit spending, is that they roll-over the securities by simply swapping new securities created by the Treasury for the mature securities and add in interest. And they do this over and over each time the securities mature. The banks go along with it because the interest is free interest.

Also, several authors I have read lately say that private banks do create new dollars when they lend. You have to accept this because when a borrower draws out his dollars from his checking account after it was increased by depositing the loan in it, the borrower can buy something with the dollars. So, dollars from the loan are now circulating in the private sector, and may even be used to pay taxes to the government. When the loan is repaid, that money is (should be) extinguished. (I have some uncertainties here about this and would like clarification fromsomeone who actually works in banks who would know. What happens to the physical cash used to pay back the loan? Surely the loan on the bank's books is extinguished. BTW see my new hubpage on The Hydrology of money flows or MMT and how do we fill the pool without overflowing?

stanfrommarietta on March 23, 2014:

John, I want to say that I enjoy your essays and responses to comments. You are a good MMT person, and your views on the Surplus and debt are essentially mine.

BTW, I read one of the Australian MMT economists this point about the why the surpluses didn't cause deflation in Australia. The economist who criticized MMT by arguing that surpluses didn't cause deflation in Australia's case, didn't think beyond fiscal (taxes versus spending) issues and consider the inflow and outflow of exports and imports or the other sources of inflow to counter the outflow to government coffers of taxes. Taxes drain dollars from the economy. That is different from spending equivalent amounts back into the economy. So what drains and what fills circulation are distinct. The government could simply shred the money that came in in the form of taxes, but if it had a record of that,

it could spend the same amount back. All that is is redistribution. But not creating new money to replace the amount shredded and spending that creates a surplus.

Folks, money is only quantitative representations in units of account of exchange obligations for goods and services between parties in the economy. Note that the money taken in as taxes can come into the government as discrete payments. The government can record the amounts and total them and do all kinds of numerical operations on that money. But in the meantime they can shred the money and send it to a landfill, because storage creates huge costs. They could burn it and heat Washington offices in winter. But there will be a record of the money received and that record will allow the government to recreate new money and spend it. The Treasury has the responsibility to carry out the spending for the government. Congress initiates money creation, Treasury acts on the authorization to create money taken in by taxes and to borrow from banks money to cover any deficit . The Treasury will roll over the debt indefinitely. But the Fed ultimately has the power to create actual real new money and buy the securities used by Treasury to borrow money from the banks. The Fed creates money out of thin air. That means nothing backs the money but the full faith and credit of the United States.

And this may seem so new and confusing because nobody has taught you all this in school. And the banks haven't wanted you to understand it clearly either. Requiring the Treasury to borrow money from banks put the banks in the position to earn collectively trillions in dollars in interest as these loans were rolled over by the Treasury. But the actual debt can be redeemed by only the Fed using powers delegated to it by Congress of the government's power to create (coin) money to buy the securities used in the borrowing.

And to the folks at the Fed, I am not saying that that extinguishes the debt obligation in the securities themselves to pay the holder of the mature security on demand the face value of the security. I think, and I wish someone who knows would say, that when the Fed swaps the mature securities for new ones with the Fed, that the Treasury can take the returned securities and extinguish them, because their redemption dates are long past, and they can't be sold at discount anymore. That would cancel the final debt obligations on those securities.

stanfrommarietta on March 22, 2014:

John said 3 months ago: "Why wouldn't the banks simply trade in their mature securities for dollars? Why would you think they would auction them off? And what price would you expect them to auction off for, if not their face value at maturity?"

Well, the interest can only be added by the government. The Fed is an "independent agency within the government" and it can buy the securities at full value without taking a loss since it is paying with government money created out of thin air.

So the Fed redeems the gov't's debt to the banks and at the same time pays the interest when it pays face value for them.

Why would any other bank wish to simply exchange dollars for the securities at face value? If it wanted interest, which only the government guarantees on these securities, there wouldn't be any, since the government would only give it face value for them. The interest already has been absorbed into the face value that the first bank would have gotten. Remember the first bank bought the securities at discount for less than their face value. So it would want face value back to earn the interest. There is no such profit for a second bank buying them at face value. The first bank would have to take a loss to sell them at discount to another bank. So, only the Fed or the Treasury could pay face value. But the Treasury we must assume may not have the money to pay face value. So, that leaves the Fed as the likely buyer. And the Fed only can buy these securities at public auction, by law.

Furthermore, the Treasury might not have the money to buy back some of these large valued securities. (It didn't have the money initially to cover the deficit, remember?)

stanfrommarietta on January 11, 2014:

Welcome back, John. I've been musing a bit over my differences with pjmelli. I think his orientation as an engineer differs from mine as a scientist. (I taught quantitative psychology, structural equation modeling, at Georgia Tech before finally retiring in 2005.) A scientist deals with abstract concepts and tries to see how they match up with the world. An engineer has abstract concepts that scientists have already determined represent some aspect of reality. He does not see the problem that you have to show that your abstract concepts represent something in reality, but assumes that they do already. I'm sorry we have these differences because it creates a false impression that MMT itself is not a coherent body of thought. Ultimately I think we can work out these differences.

BTW, do you follow some of the papers and videos of Stephanie Kelton? She is the chair of the economics department at University of Missouri at Kansas City, where Wray, Marshall and others are. She gives popular talks on MMT. My point in bringing this up is that she very clearly says that MMT is not just theory but a "description" of what actually is happening in our government's finances.

"I think that others who began to follow our work branded us with this title and started referring to us as the Modern Money School and to our ideas as Modern Money Theory and in many ways I think it’s kind of unfortunate, but this is the brand that we now, or the cross that we now bear, because it is something of a misnomer. What we’re doing is actually not modern at all. The ideas are not theoretical, and they aren’t particularly modern. What we’re doing is simply describing, operationally, the way government finance works. It’s not a theory; we do not make assumptions, although we are economists. What we’ve been describing to you today is not dependent upon any ceteris parabis condition or any set of assumptions about perfect competition or rational agents or anything else that you get exposed to when you study economics, but rather an attempt to simply describe the way in which the institutional arrangements are set up, and the accounting identities and what happens in a balance sheet framework; when one side of the equation moves, what happens on the other side of the equation? That’s really all we’re up to, so don’t be afraid."

That's at:

John (author) from Cleveland, OH on January 03, 2014:

Sorry for the delay, Stan. Christmas vacation with the kids.

Yeah, that credit thing was a flub on my part. I was caught up in the "credits = liabilities" thing, I think, and the $100 liability would prevent one from spending money down the road. Anyway, the sheer volume (and speed) of the comments in this thread was a lot to keep up with, and it got sloppy at times. :) Plus, KenDonHank was obviously not just one guy cranking out comments. That debate was a full-time job.

I had some things a bit wrong back then (I'm sure I still do today). But I still think that the key is HPM, not bank credit.

FYI, another MMTer has joined HubPages, and he already cranked out a few articles. Things are looking up.

stanfrommarietta on January 02, 2014:

John, I noted above quite some time ago you said:

"Also - if you count credit as money, where did that money come from? If a bank loans you $100, doesn't somebody else have $100 less to potentially spend?"

You seem to have the notion that when private banks create loans they are taking some of their depositor's money and giving it to the person lent to. At least that is how I interpret your saying "...doesn't somebody else have $100 less to potentially spend?"

That's not how banks loan these days. They create new money when they lend. But it is only a loan and the bank must be repaid plus interest. The interest is what the bank is after. So private banks creating money can be inflationary if too much new money is being created before being cancelled out again on repayment. That's how the housing bubble grew. It was private banks making easy loans. People were seeing prices of houses rise because of all the easy money going into house construction was inflationary. So, people would buy a house at a low price and hold the house for a short while, then sell it again at a higher price, expecting prices to rise even further. The loans for buying the houses were easy to come by. This is private banking doing this.

stanfrommarietta on December 25, 2013:

The concern that rolling over does not add new money into the economy is well-taken. The method I described where the Fed buys the securities for deficit spending does indeed do that. I think much of what Newman describes are those securities bought by banks with excess reserves looking for a safer investment. These securities are like CD's. The Chinese and Japanese buy them all the time with surplus dollars from exports to us (imports to us). They stay within the private banking system and do not add to the money in the system.

It is interesting that no one wants to say that the Fed redeems the debt when it buys

back the securities for banks holding them with money created out of thin air. I detect a fear that if this becomes well known, the power to do this may be taken from them by Congress (an absolutely stupid thing to do, but what do we now have in Congress? I fear that by keeping this under wraps will only make the possibility of that happening worse.

stanfrommarietta on December 23, 2013:

I know, that is a common assumption, i.e. Treasury must find money to buy back the mature securities from the Fed. But my essential point has been that there is no need for the Treasury to find money to buy back the securities. The securities have been bought for the government by the Fed. There is no longer a debt to a given bank. To have Treasury turn around and buy them would have the government buying them from itself, and furthermore a second time, which would be unauthorized by Congress.

Your issue with me is rhetoric. What is the best way to present the argument? You want to present the argument to the average schmo in a simple manner. I have no argument with that as long as you are accurate and not misleading. But I want to show that while it appears there is a debt when Treasury sells securities to banks (etc.) to fund deficit spending, which the average politician and citizen calls "borrowing", the debt has been redeemed to a given bank when the Fed buys the security with money created out of thin air. (This does not extinguish the security; it just eliminates the debt to the bank that held the security and puts the security back in the coffers of the government.)

I am reading another book by Frank N. Newman, "Freedom from National Debt". He essentially has an MMT view, but sees the issues of debt from the perspective of a former Undersecretary of the Treasury and Chairman and CEO of several banks, including a bank in China that some private investors bought. So, he has seen another government with a fiat money system (China's) and how it relates to banks.

I don't see how rolling over would ultimately exhaust the money supply. If bank A bought securities S1 from Treasury, and Treasury wanted to roll-over the debt to bank A, it would borrow the required amount from other banks B using a new set of securities S2. Treasury would give bank A the money from banks B and that would redeem the debt of govt. to bank A. Treasury would take back securities S1. But now it has a new debt equal to the old to banks B. In the meantime bank A has its reserves restored and its money back including interest. But Bank A may use its restored reserves to lend more money into the economy. So, the money in circulation is the same but in different hands. The same bank reserve money is cycling around in circulation at different banks, but as long as the banks have enough to cover the security, the Treasury can borrow from them. The banks B now have new securities S2. Treasury may at a future round, issue new securities Sn to banks H to pay off a previous set of securities at some other banks. Bank A may be bank H using money it got from Treasury that it got from banks B, etc.. As long as at any given point in time only a smaller subset of securities are mature and need to be rolled over at the banks, there should be enough money in the banks to to make these "loans" to the Treasury. So, this can go on forever without ending. It doesn't cancel national debt, but puts its payoff to forever. That was the idea I had in my earlier message.

Newman says that a slightly different system is used between Treasury and banks to put off paying off the debt. He says: "Sometimes people think of Treasuries as a form of 'debt' because each bond can be converted to bank dollars at its maturity. But the issuance cycle is really an operational matter. **New Treasuries take the place of previous ones, with the same backing of the U.S. Government. ** Only the interest rate changes, and investors continue to hold them as the most reliable USD financial assets. It's very like issuing Treasuries without expiration dates, which simply adjust interest rates to the current market at predetermined periods: some have their interest rates based on prevailing rates for three months, and the rates reset every three months, by an auction process; others have interest based on market rates for one yer of five years, then reset to the then applicable rates every one year or five years. The concept is essentially that used for long term (or undated) floating-rate bonds. All these Treasury securities are fully tradable, and the government, which can always create more bank money, can retire any security and change the timing mix of interest-rate resets, through open market operations. {This sounds like what the Fed does}. The securities could be structured in such a form, but instead the Treasury uses a system of series of new issues, which does not change the underlying essence. This program has functioned very effectively for hundreds of years, with never any need to 'pay off' the aggregate" (pp. 30-31).

So he is seeing how Treasury and banks can deal with the 'debt'. He does not see how the Fed totally pays off the debt when it buys a security, but still has active, live securities to sell. He does not note the way Fed swaps mature securities for new securities with the Treasury. But that may be a matter of what he has experienced as an Undersecretary of the Treasury and a CEO of several banks.

But the point that Newman makes is that taxpayers never have to pay for the debt, contrary to what everyone believes. Either the way of the Fed or the Treasury does not require taxpayer involvement. There is no real debt problem.

My use of credit versus debit comes from reading Ellen Brown's "The Web of Debt". She viewed the banks' lending at interest as creating debt-based money by loans which had to be paid back from money in existence. There would never be enough money in existence to pay off the actual debt plus the interest. She argued that the greenbacks method issues credit and not debt. If someone credits you, you don't have to pay them back. Hence if Congress deficit spends with credit money, it does not have a debt problem. If, on the other hand, Congress deficit spends and has to borrow money to cover the deficit, it has debt-based money. So, if we can show that the Fed's ability to create new credit money out of thin air when it buys back the securities for the government, that redeems the debt to the banks, makes the deficit spending money debt-free and fungibly equivalent to the new money deposited in the banks' reserves.

There are a lot of people with misconceptions about our federal government's finances. They are not all dumb, uneducated shmos. Many of them are even Ph.D.; economists in the neo-classical school (the predominant one). So, they want to see how the details work out with there not being a debt problem in our actual system.

John (author) from Cleveland, OH on December 22, 2013:

"...That is the "roll-over" of the securities. This process, it is said, can occur ad infinitum, without end, so there is never any time that the debt will ever be finally repaid. Old debt is replaced with new debt, on and on, ad infinitum.

The assumption is that the Treasury must find the money to to buy back the mature securities from the Fed. And it does that by issuing new securities to cover the cost of the mature securities. This is a way anyone with debt can postpone ever paying it back, as long as the debtor can borrow more money in existence to cover and repay the old debt."

You cannot "find" enough dollars already in existence to keep on rolling over the debt. At some point, new dollars must be created to account for growth. There are over $1 trillion dollars in circulation today - it wasn't all that long ago that there wasn't even $1 trillion in (currency + bonds). Borrowing more money "in existence" would have to entail bank credit, with the non-governmental sector holding an ever-increasing pile of liabilities.

John (author) from Cleveland, OH on December 22, 2013:

Sorry for the delay in replying. It's a busy time of year for me.

"John, Pjmeli does not want to discuss further with me. But what do you think? I am trying to show how our system which separates the authorization of money by Congress from borrowing using securities by the Treasury, by the Fed buying securities with newly created money made on the spot from the banks, achieves the same thing as a greenback system."

That's what we're all trying to explain, Stan. Problem is, nobody wants to get that deep into the details, including me. I think they are a distraction - and I like reading about this subject. Now imagine the average schmo trying to absorb all of that. The average schmo understands his or her checkbook, and that's about it, so we really have to keep it simple.

With that in mind, I prefer not to think of dollars in terms of debt, because the whole point of this is that fiat dollars are effectively debt-free. Even introducing the "D-word" into the conversation changes the tone, and not in our favor. I think it's a big mistake in our efforts to educate people. Average Schmo understands debt in one way only - the kind of debt that they experience costs them real resources (their labor/money). Most don't understand double entry accounting, or that the word "liability" is not always a negative thing.

" In the greenback system, when there is a deficit, the Treasury issues and spends credit money..."

Aaaarrghhh! Why do you call the simple distribution of money "credit money"? That's confusing as hell. You go on to call the government exchanging one dollar for another (presumably a nice, crisp bill for a torn one?) a debt situation. Confusing! And as far as treasuries are concerned, I much prefer to use the checking account/savings account analogy.

"You seem to have read Frank N. Newman's book."

Nope. I don't do that kind of study on MMT. Honestly, I don't feel that it's necessary to get that deep into the details. I am very happy with my present, big-picture understanding of things.

Stan - you have already stated that you think it is important to illustrate that our government effectively issues debt-free dollars, which I totally agree with. But why do you think the details are so important? I mean, who is your audience? And what is the main point of your last couple of paragraphs? I think I asked you earlier - what is to be gained by re-complicating our simplifications?

stanfrommarietta on December 20, 2013:

John, Pjmeli does not want to discuss further with me. But what do you think? I am trying to show how our system which separates the authorization of money by Congress from borrowing using securities by the Treasury, by the Fed buying securities with newly created money made on the spot from the banks, achieves the same thing as a greenback system. In the greenback system, when there is a deficit, the Treasury issues and spends credit money directly into the economy (when authorized by Congress). This money is debt free (except for the debt obligation that if a citizen presents a dollar bill to the government (Treasury), the Treasury is obliged to exchange another dollar for it. Or if a citizen pays taxes in dollars, the government must honor the payment. There is no debt to anyone from whom money has been borrowed attached to any security bought from a bank or swapped for an immature security in the pile of securities at the Fed. All debts to borrowers have been redeemed. The securities at the Fed are still "live" in the sense that if sold to someone, the government then owes the holder of the security for the face value of the security at any time beyond the redemption date. So redeeming debt to a specific bank that held the security is distinct from the debt obligation to exchange another dollar for one presented to the government, or to honor taxes paid, or to provide services or property to buyers with dollars.

You seem to have read Frank N. Newman's book. I just became aware of it by a pop up of a notice for the book at He is pure MMT, except that he seems to think that rolling over the securities at the Fed resolves the debt problem instead of recognizing that the debt to the bank has been paid (redeemed) by the Fed buying the securities with new money. That would make it illegal for Treasury to buy the older mature securities from the Fed with money borrowed from the banks. The Fed of course would end up buying the new securities used by Treasury to borrow the roll-over money when they matured, ad infinitum. That would effectively replace the old securities with new ones in the roll over. But that is buying something twice. (First buying: Fed buys securities from banks. Second buying: the Treasury buys the same securities, now at the Fed, with borrowed money, or a platinum coin.) And Congress only authorizes redeeming the first borrowing.

If the Fed simply swaps mature securities for new (immature) securities with the Treasury (as it does now) that is not a roll over by borrowing. But it accomplishes nearly the same thing. The Fed does not normally buy immature securities. So, it would not ordinarily have immature securities that it bought. But the Fed wants immature securities to sell to banks to drain their reserves of excess reserves during inflations. Banks do not want to buy mature securities (since T securities are sold at discount and the difference between selling price and face-value is the interest earned). Mature securities, if sold, would not earn interest, so there is no advantage to a bank buying them. So swapping mature for immature securities is the way the Fed would prefer to acquire immature securities.

stanfrommarietta on December 16, 2013:

There are those, among them even MMT followers, who believe that the solution to the national debt problem is to roll-over mature securities to new, immature securities. The Treasury is expected to find dollars to pay off the debt of the securities held by the Fed. One thing it can do is borrow some more money equal to the face value of securities it wants to roll-over.

To do this it issues new securities, which banks buy at auction. Treasury then buys back the old, mature securities at the Fed with the money now obtained from the banks. That retires the mature securities, but the Fed then buys the new securities from the banks at auction. This replaces the old securities with the new ones. That is the "roll-over" of the securities. This process, it is said, can occur ad infinitum, without end, so there is never any time that the debt will ever be finally repaid. Old debt is replaced with new debt, on and on, ad infinitum.

The assumption is that the Treasury must find the money to to buy back the mature securities from the Fed. And it does that by issuing new securities to cover the cost of the mature securities. This is a way anyone with debt can postpone ever paying it back, as long as the debtor can borrow more money in existence to cover and repay the old debt.

This makes sense only in the context of finding money already in existence to borrow. It is what you would expect of any household's credit card, business issuing bonds to grow, state or local government. But is it necessary for the Federal government to do this?

Right now that is the way the Fed and the Treasury act. The Fed has all these securities it has bought. Somehow it is thought the Treasury owes the Fed the money it has spent in buying the securities. Either the Treasury will get the money from taxes or from banks which already have money to lend. So, the Treasury issues new securities, banks buy them and then the Fed buys the securities with money it creates out of thin air. (The implications of that are ignored). The Fed now holds the securities. Treasury buys back the old mature securities with money obtained from issuing new securities. Fed then buys these new securities from the banks. Each purchase by the Fed means the Fed will get 6% of the interest on the securities it buys as a transaction fee. So this becomes a steady income stream for the Fed.

But is this method legal? What is being overlooked here is that the Fed is a government agency, perhaps independent within the government, but a government agency nevertheless. And its buying of the securities is not with old money already in existence drawn from the reserves of the member banks of the Federal Reserve, but newly created money--government money--created by powers delegated to the Fed by Congress based on Article I sec 8 of the Constitution, the power to "coin" Money and regulate the value thereof. (Coining has already been established to mean "create money generally" by the Supreme Court in some late 19th Century decisions). So, the Fed in effect has already redeemed the debt to the banks in the securities they held when it bought the securities from the banks. The banks no longer have the securities. They have their money back in return for them. They have sold them to a government agency for government money. That means the debt has already been paid by the Fed for the government.

So, this creates a problem for roll-overs and $1 Trillion coins as solutions to the national debt. The very fact that the securities already exist at the Fed because the Fed bought them, means the debt to someone who lent Treasury money for those securities has been repaid by the government.

So, what authorizes buying them a second time under the guise of the Treasury repaying a debt? There is none. Congress only authorized the initial debt in giving Treasury its spending order, and the Treasury having to find money to cover the deficit in that order (and the 1917 law requiring the Treasury to borrow money to cover deficits). I know of no organization that would authorize paying off its debts twice. And Treasury's buying securities held at the Fed is a second purchase of the same securities by a government agency. Government does not owe itself here.

The Fed is the money creator and spender that redeems debts by buying their IOU's from their holders with newly created money. So, there is no debt left to any non-government entity in those securities at the Fed.

The purchase of the securities from the banks does not extinguish the securities property of promising to pay the bearer their face value after maturing. Once mature, they are just like dollar bills. But the Fed cannot claim to be eligible for those payments because it only applies to an entity beyond the Treasury and the Fed. (The Treasury does not owe itself the value of the securities it holds before it sells them. The Fed is not owed by Treasury for the government securities the Fed buys and holds with government money).

The Fed swaps mature securities for new, immature ones from the Treasury. This is legal, since no ordinary money changes hands. There is just an exchange of securities. But this should be seen as just the Fed desiring to obtain new, immature securities with new future redemption dates, because it wants to sell them to banks later if and when serious inflation arises, in order to drain the banks' reserves and constrain lending. The swap involves exchange of instruments with equal value. The Fed's mature securities "pay for" the new securities. Their face value will not be the value for which they will be sold at public auction to the banks. But their face value will be the value they have at maturity. The Fed will easily redeem these securities by buying them with money it creates out of thin air.

I have often wondered why the Fed acts in such a way as to disguise its purchase of securities with money it creates out of thin air. The Fed finds many ways to say this without clearly stating the money is created. The "Fed draws on itself and increases the reserves of the bank". What makes them want to obscure this? Although they are making money in transaction fees on these transactions, it could be they fear another law like the 1917 law that prevented Treasury from creating and spending its own money, the "greenbacks" solution. Once austerians in Congress see that Fed's buying with money created out of nothing eliminates the national debt problem they may pass laws that prevent the Fed from doing this. It would cripple our economy, make us like Europe and the Euro. And lead us into an unending downward spiral in our economy. And China, which has an unfettered fiat money system which has allowed it to grow its economy into a world powerhouse in just 20 years, with new infrastructure (roads, bridges, buildings, military), would be in a position to displace the United States as the leading economic power of the world.

stanfrmmarietta on December 15, 2013:

Pjmeli: "The money supply increased when Congress appropriated funds for spending, and the President signed the bill, not when Fed increased reserves, but we've been over that umpteen times.

We may be talking about the same thing. I