<bizaro86>
I'd like to invert this with a question (selfishly to aid my own understanding). What would cause inflation? We know inflation is possible because it has happened in the past.
<mattee2264>
Yeah I think large budget deficits accompanied by a recovery of private sector spending could do the trick with higher commodity prices and supply constraints adding some fuel to the fire.
I'm glad these accounting ledger views are helping folks visualize what's really happening with these different government payment flows. So with that I want to show the three basic payment flows that we've been talking about:
1) The Federal Reserve buying a US Treasury bond in its open market purchases. (it is not technically allowed to buy it directly from the US Treasury)
2) The US Treasury spends. (because the US Treasury runs a perpetual deficit - it must spend more than it takes in via taxes. But I could also focus on a tax payment too - flows would just reverse)
3) The US Treasury issuing a bond to the private sector.
Here's the key takeaway: Only deficit spending (scenario #2) from the US Treasury actually creates new money (i.e., new net financial assets) for the private sector. The other two flows leave the private sector with exactly the same net financial assets as it had before, it just changes the form of that financial asset composition.
Ok - so if you've read this far. Let's go through all the payment flows. I'm going to expand the accounting ledger beyond the Fed and a bank (JP Morgan Chase) to add the US Treasury and an Individual/Business Account (which is a proxy for the private sector). I'm consolidating the govt sector by combining the US Treasury and the Fed on one side (in blue) and the private sector (bank + individual/business) on the other side in green. The key to focus on is the effect on the net financial assets of the Individual/Business sector. Focus on which of these three flows increases the net financial assets - highlighted in yellow.
First up - the one payment flow we've already covered. The Fed buys a Treasury Bond. In this case, I've made a change. I've had the US Treasury Bond originate from an Individual/Business through a Bank to the Fed. Before we just had the Bank dealing with the Fed directly. [click on drawing for full screen viewing]
I'm not going to go over this one because we've been over it. Notice though that this payment flow does not increase individual/business net assets.
Next up - the US Treasury deficit spends. Here the US Treasury issues $10m in CARES Act checks (for example). The Treasury tells the Fed to issue a payment order and the Fed moves electronic deposits from the Treasury's reserve account to JPM's reserve account. This creates both a reserve asset and a bank deposit liability for JPM. But for the private sector - this is a new net financial asset. Therefore US Treasury deficit spending creates "new money" for the private sector and increases the private sector's net asset values (in terms of the "government's money".
Finally - the US Treasury issues a bond. Here the private sector buys a bond from the US Treasury. Notice again - that this is an asset swap. The private sector does not see an increase in its net financial assets. It's balance sheet stays the same as before buying the bond - it just changes the asset mix.
A long-winded way to answer the question is that the only thing that increases money, banking deposits, net financial assets in the hands of the private sector is US Treasury deficit spending. Everyone worries about the Fed, the banks, lending - but all of the real action is here. This is what one needs to pay attention to. The Fed and the banks are just intermediaries that manage the payment flows through the payment systems.
I'll just add another comment. File this under = advanced topics. Compare Payment Flows 2 and 3. Notice how the act of US Treasury Spending creates an equal in size reserve balance for JP Morgan? Notice how after issuing a Treasury bond, the bond relieves JP Morgan of that large reserve balance even as it maintains the increase in net financial assets for the private sector? (ie, the bank deposit asset is changed into a Treasury bond asset for the Individual/Business sector). This is why we say that Federal Government Debt issuance isn't really borrowing - its a reserve maintenance function. This means that if not for the borrowing, US Treasury spending would create unwanted and large reserve balances in the US commercial banking sector. This is why one can't think of a sovereign borrowing in its own currency as simply borrowing the way we think of it for individuals, businesses, local and state governments that don't create fiat currency. Federal borrowing serves a different function than funding the government.
I know this last point can be confusing. It is made confusing by the rules that the Congress puts in place to make it look like the government must tax or borrow to fund spending:
- the US Treasury cannot run an overdraft at its general account at the Federal Reserve (i.e., no negative balance),
- the US Treasury cannot borrow beyond an absolute level (ie "the debt ceiling")
- the US Treasury must issue its bonds to the public (and not the Fed).
- the Fed must buy its Treasury bonds in the open market.
Its important to note that these are all political constraints, and not economic ones. The only economic constraint is that the private sector must want and need the Federal government's money. This need is not created by legal tender laws or contracts. It is created by the tax obligations that the Federal government imposes on the private sector and then mandating that these tax obligations can only be extinguished by using the Federal government's money.
Hope this helps and I just haven't confused everyone with my ramblings. I'm still learning this stuff myself.
wabuffo
wabuffo, thank you for a gracious, thoughtful, beautiful explanation.
I'd like to first mention that a young guy named Nathan Tankus gained a lot of notoriety over the last year posting blogs explaining complexities of the financial system using the same kind of visual, T table-based, explanations you use. His fan base exploded when Bloomberg featured his blog in a story. You might like his posts:
https://nathantankus.substack.com/Also, just to be sure I'm correctly synthesizing the Hunt/Hoisington position with your explanation above, is it fair to say scenario 2 cannot legally happen independent of a corresponding tax receipt or treasury issuance? In other words, the government cannot legally create new private sector assets without taxing the private sector or increasing public sector debt to pay for those assets?
Thus, making the Hunt/Hoisington case that deficit spending is near term inflationary (6 to 18 months) due to temporary supply constraints, but longer term deflationary, because the additional public sector debt decreases prospects for longer term private sector productivity/growth (as the private sector will be on the hook for servicing the additional debt). I believe this has been the ongoing rationale for Hoisington's position in long term treasuries - that the global, central bank-driven, debt explosion of recent years is long term deflationary.
However, I believe in a recent newsletter Hoisington warned if the US congress legalizes scenario 2 above without requiring corresponding taxation/debt - aka legalizes true money printing - that all bets are off. Sounded like if that happened Hoisington would unload their long positions overnight, while expecting devastating, Weimar Republic-style, economic consequences (hence, the reason true US government money printing has been illegal thus far).
