Sunday, June 2, 2013

Does Credit Drive the Economy?

Much of the commentary on the economy seems to assume that it is driven by credit. The statement often made in blogs and news articles is that 90% or more of the money in circulation is private debt, the rest coming through net government spending, so clearly credit (debt) must be the main driver of the system. It's obvious. A caveman could see it.

I believe this is a gross mischaracterization of how the system actually functions.

Where do these claims regarding credit domination of the system come from? Is it truth or fiction. From what I had seen it was nothing more than an article of faith, I had never come across any proof or support that this was actually the case.

Based on the claims, the "money supply" people must be alluding to is the supply of dollars in existence within the domestic non-government. This is pretty simple number to figure out…

…The total level of state money in the private economy should be equal to all public spending plus all private debt outstanding less federal taxes and net exports.

All we have to do is compare the two sources of spending over time to get a handle on their respective contributions to the "money supply" that is being alluded to.

The solution requires downloading some data from FRED and making some necessary adjustments because some datasets are annual amounts and some are accumulations or running totals. The data we need:

1. FGEXPND - Current Federal Expenditures (Annual totals, must be converted to a running total (a balance) to be compatible with TCMDO). This is equivalent to adding a balance column in your checkbook.

2. TCMDO - Total Credit Market Debt Owed. Straight from FRED, a balance.

3. FYGFDPUB - Federal Debt Held by the Public. Also straight from FRED, also a balance.

Why do we need FYGDPUB? Because TCMDO includes public debt, which we must subtract to get to the total private debt.

The first step is to prepare the data and enter it into a graphing program. Converting FGEXPND to a running total gives us a series I've called rtFGEXPND.

TCMDO minus FYGFDPUB gives us a private-debt only series I have labelled pdTCMDO.

Next, we have to sum the two series rtFGEXPND and pdTCMDO to get the Total annual spending series.

Finally I created a series that plots Private Debt as a percentage of Total Spending. Note that it is not necessary to subtract federal taxes or net exports from the series to get the ratio, they merely reduce the level of money supply not the ratio between public spending and private debt. The relationships in equation form are:

Money Supply = rtFGEXPND + pdTCMDO

pdTCMDO(%) = pdTCMDO ÷ Money Supply

The graph of the result is shown below:



Since 1970, credit has accounted for between 36% and 47.5% of the total number of dollars spent into the economy (and bad things happened at that peak), currently standing at just under 40% of the "money supply". My seat-of-the-pants observation is that a healthy credit/public spending ratio is centered at no more than about 40%.

At no time in the past 43 years has credit ever accounted for anywhere near 90% of the "money supply". It's an urban legend.


29 comments:

  1. I think you are forgetting about Government taxation. Govt. created money supply = expenditures - revenues. Expenditure creates money, while taxation destroys it. Accumulated deficits = net government created money in the economy. Your charts will have a different look

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  2. Interesting! Isn't Cullen Roche (pragcap.com) the one who is always talking about this? I've often wondered about the data supporting his perspective...

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  3. …The total level of state money in the private economy should be equal to all public spending plus all private debt outstanding less federal taxes and net exports.

    I don't understand this at all.

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  4. "I don't understand this at all." - Dan

    State Money in Existence = ∑Public Spending + ∑Private Debts - ∑Federal Taxes - ∑Net Exports. (∑ = "the sum of", over history)

    ∑Public Spending - ∑Federal Taxes = ∑Deficits.

    How many dollars are there in the domestic economy? is the question.

    Dollars come from two sources at the point of entry (to the non-government)…public spending and private debt issued.

    At the point of entry spending "creates" new money, so this is not ordinary spending.

    After the initial transaction that "creates" the money (or dollars if you prefer) spending does not effect any change on the level of dollars…they just move around within the economy.

    Those dollars have become a part of the "stock" of state money that remains unchanged until it is modified by some external transaction:

    1. Federal Taxation

    2. Trade deficit

    3. More public spending

    4. More private debt creation.

    These transactions are identical to the transactions that remove and add money to your household bank accounts.

    That money comes from a source external to your household (someone else), just as money (currency, electronic or otherwise) comes from an external source (thin air).

    The difference between household accounting and government accounting is that households can't create dollar balances from thin air.

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  5. This seem to me to be an ingenious insight -- i.e.

    In terms of new money (purchasing power) creation, gross government expenditures should be compared to net private credit, since taxes come out of all money equally. This is huge in terms of the implications...

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  6. Detroit Dan,

    I'm glad that you see the point I was trying to make. Your comment is a very succinct and to the point summary of the post…more to the point than the post itself…but I was trained to show my work ;-)

    and a h/t to Matt Franko, who has helped to formalize these ideas in discussions we've been having in recent months via e-mail.

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  7. 1. "annual amounts" = FLOWS
    "accumulations or running totals" = STOCKS (though I also like the word accumulation)

    2. Government spending does not accumulate.

    3. Gross government expenditure is not a net addition to money in the economy, it is a gross addition. As Clonal said, and as YOU said, you have to subtract out gross government revenue to get the amount of money added to the economy by government spending.

    4. "All we have to do is compare the two sources of spending over time to get a handle on their respective contributions to the "money supply" that is being alluded to."

    You "alluded" explicitly to "the money in circulation" in your opening paragraph. In order to measure that particular quantity you must subtract "federal taxes and net exports" and you must also subtract the money that remains in the economy but not in circulation: savings.

    5. "The total level of state money in the private economy should be equal to all public spending plus all private debt outstanding less federal taxes and net exports."
    5a. It blurs the line to count "private debt" as "state money".
    5b. Your statement assumes that no money ever drops out of circulation and lands in savings. Or we could say money in savings is still "in the private economy" but then you're not talking about "money in circulation" any more. However, it is the circulation of money that "drives" the economy.

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    1. We have a common goal here, so let's focus on "YES, AND" rather than "NO, BUT" - so that any readers can learn and proceed, rather than just witness bickering.

      Here's one suggestion. This is largely semantics?

      "State Money" - is that ONLY the currency actually injected by state contracting, or ANY currency denominated in the form of state currency?

      Just define the terms as you intend to use them - and accept that semantics, like modern currency, is by fiat.

      To at least some non-bankers, "FIAT" implies that all state-denominated currency is created and accurately tracked by the "state," since private and public are now co-owners of the [automated] currency-creation process. It's a distinction that not all care about in the same way.

      What matters for outcomes is automatically "right-sizing" the currency supply needed by an auto-adjusting population and their auto-adjusting transaction activities. Just keep that in mind?

      Delete
    2. "2. Government spending does not accumulate." - Art

      It doesn't? Government spending puts dollars in bank accounts in the domestic economy.

      Exactly the same thing occours when people borrow money and spend it.

      Both accumulate in the economy, both levels are reduced by taxation. When you fill a pool from two hoses the water in the pool all looks the same.

      It's identical to the flows in and out of your checking account. Do you choose each dollar individually to pay your taxes? Or do you just submit a number written on a check?

      "Gross government expenditure is not a net addition to money in the economy, it is a gross addition" - Art

      That is exactly my point. I didn't compare nets. I could have done the same thing on an annual basis with the budget…

      Year…Public spending…private debt…ratio
      1970…201.60…94.14…31.8%
      1971…220.60…109.81…33.3%
      1972…245.20…149.20…37.8%


      2010…3703.40…-1883.32…N/A (can't calculate the ratio between a positive and negative number)
      2011…3757.00…-69.13…N/A
      2012…3757.70…203.05…5.1%

      The years when private debt expansion was negative rules out that methodology, there would be a hole in the graph. Imagine me trying to explain that.

      I thought it would be less confusing to calculate the ratio of end-of-year running totals.

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    3. …continuation from previous comment…


      "In order to measure that particular quantity you must subtract "federal taxes and net exports"" - Art

      I pointed out in the last paragraph of the post that subtracting taxes and net exports was unnecessary to calculate the ratio of composition of dollars in the economy. Subtracting taxes and net exports acts propotionatly to the money in the "pool". I was trying to keep the post brief.

      I made no effort to present totals, but I had to have Total Spending to do the calculation…spending from thin air is "money creation"…anyone that wants to can subtract taxes and net exports. The point of the post is the ratios, which answers the impied statement.

      Anyway, to the point…taxes do not subtract only from income that come from public spending…as I explained earlier.

      "It blurs the line to count "private debt" as "state money"." - Art

      There is no question that bank-issued money is state money. Go to the bank and get a loan…take the proceeds in cash…read what is written on the bills. Mix them up with bills received from a government paycheck…try to pick out the bank-issued bills.

      "Your statement assumes that no money ever drops out of circulation and lands in savings. Or we could say money in savings is still "in the private economy" but then you're not talking about "money in circulation" any more. However, it is the circulation of money that "drives" the economy." - Art

      I make no such assumption…in fact I agree completely with what you just wrote here…it's my mantra. I'm sure I've written something very similar in comments on your blog.

      Again, the statement has been made many times by others that "90% of the money supply comes through credit"

      This is not true for flows, nor is it true for stocks (or running totals if you prefer, which is what a stock amounts to…as I have shown.

      BTW, mathematically a flow can be a stock but a stock cannot be a flow. If you have a dollar in your pocket it's a stock. If you spend it or give it to someone it is at that instant a flow. Then it becomes someone else's stock. This occurs every time transaction takes place. The natural state for money is as a stock…it is only a flow at the moment of transaction.

      The money in "circulation" is a small percentage of the "money supply" we are discussing here. This idea has been the basis of nearly all of the comments I make on the internet.

      Most of the questions and criticisms seem to stem from the same problem…making something much more compplicated than it actually is, and trying to make semantics trump arithmetic. I'm not a professional writer, I'm an amateur…but I'll put my expressions describing what is going on in a system up against any economist alive. They don't do a very good job with semantics…their track record of explaining reality is abysmal.

      Anyway the main difference here is that your idea of a stock or a flow is in some way different than mine. Then look at the logic and not the words.

      I use the language of mathematics, where the definition of parameters is clear.

      Delete
  8. nice; ps: more novice readers would catch on if you'd relabel the chart lines with simple names instead of the acronyms

    Next, let's talk causality? (ask "why" 5 times? maybe 6)

    1) Why the swings in (bad) private debt? (too much credit?)
    2) Why too much credit? (sloppy risk/uncertainty mgt?)
    3) why declining ratings stds? (loosened regulation of fraud?)
    4) why the loosened regulation? (ignorance, inexperience? falling back on local tactics instead of distributed strategy & policy?)
    5) why the ignorance & inexperience? (we quit talking to our grandparents?)
    6) why are we more ignorant than our grandparents? (out of training?)

    Whoa! Time to hit the "systems" gym, and put in the coordination practice?
    [cross-training on tactics, strategy, policy, goals, AND outcomes? SIMULTANEOUSLY? Not just local tactics? Ya THINK?]

    First, Bill Black's correlation implies that improperly rated private credit (i.e.,"liars loans") fosters excessive debt ... which then fosters a runaway Gresham's Dynamic.

    So, what's wrong with our policy? We're debating currency supply (fiat "deficits") instead of tax rates and aggregate demand? Yes, but NOT for the reasons that most people assume! It's a problem of perception. We ain't got any! (or, at least too many of us don't)

    We're not only debating the irrelevant, we're also replacing policy with special interest tactics, and thereby abdicating policy altogether? Where's the public-purpose discussion in any current politics?

    When we end up as random tactics masquerading as national policy ... bad things happen, and the tacticians never understand why outcomes go down the crapper. If they did, they wouldn't have over-lobbied for their tactics in the 1st place!

    So why would anyone over-lobby in the 1st place? These progressions always result from a breakdown in communication, education and practice. An untrained, unpracticed squad makes more mistakes, which quickly spiral out of control - if not quickly checked. This ain't rocket science.

    We've become a disorganized nation. We need a drastically better "initiation program" - a "rookie camp" - for adequately orienting all incoming citizens and policy staff. [We used to call that education.] We've let standards slip way too low, and now we're too far behind the times.

    Nothing to worry about, if we're ready to act.
    https://plus.google.com/u/0/104140272098689841413/posts/1wvNZTj6Z9t

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  9. So, to carry on with one thought raised in the comments.

    First, we get lazy, and let various fools propose and accept liars loans.

    Second, we
    a) let those accepting liars loans get socked with higher taxes.
    b) let those writing liars loans that go bad .... get bailed out (with state-spent-currency).

    So the secondary complications from the initial disregulation are what really hurt our nation the most? Those complications aren't yet on the chart - but can be added.

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    1. Roger, agreed.

      I suppose the simple rule is…don't allow credit creation (regulated public-private partnership) that you aren't prepared to provide the income to repay (policymakers in government).

      It's another right-hand-left-hand problem…the right hand is unaware of what the left hand is doing…and probably believes it doesn't have to.

      These clowns think that the banking system provides for both.

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  10. Maybe I have missed it but I don't understand a couple of things, maybe the same problems that Dan Kervick has.

    1. Why is the amount of money spent compared to the amount of money created? Can't a single dollar be spent again and again? Doesn't the velocity of money come into this situation?

    2. If it is proposed that only 40% of money comes from credit, then where does the rest of it come from?

    Bottom line: This is a great discussion but seems too circular to me, without coming to any conclusion(s).

    John Lounsbury

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  11. "1. Why is the amount of money spent compared to the amount of money created?"

    John, it's the amount of money spent by the government and by borrowers from FRS banks into the economy.

    That accounts for all possible (state) money creation to the penny.

    Users of the currency do not create new money when they spend no matter how many times a dollar is spent. This spending facilitates the movement or flow of real assets. Creation of real assets does not expand the money supply.

    Then the cycle must be repeated. It is done so on an annual basis for public spending, on a continual basis for spending created from private borrowing.

    "Can't a single dollar be spent again and again? Doesn't the velocity of money come into this situation?"

    The velocity of money is the rate of spending…it's a measurement, it is neither a flow nor a stock. It is an observation. It isn't something one can hold. It's like the speedometer in your car.

    GDP is much the same. It is a measurement, an observation. Spending within the economy cannot alter the level of funds unless something is bought from a foreigner out of the country, in which case the level goes down.

    In a chain of transactions involving a dollar, at any given moment it is only poosible for one person (or account) to hold the dollar.

    Every dollar saved decreases velocity.

    "2. If it is proposed that only 40% of money comes from credit, then where does the rest of it come from?"

    It is stated explicitly in the post that it comes from public spending. There are only two sources of state money…public spending and spending that results from the expansion of private debt through FRS banks.

    The conclusion is that of the roughly $58T dollars in existence 35.8 trillion came from public spending and $23.2T came as a result of private borrowing from banks.

    There exists simultaneously $44T in dollar liabilities that can only be satisfied with dollar balances. Most of the balances are savings…how are payments made?

    Private debt spending is self-limiting… only a portion of incomes can come from the expansion of private debt, but all of the debt service comes from income. So once we reach an equilibrium…like where we are now…there is thus one sustainable source of spending to drive economic activity…public spending.

    Without it there would be near zero flow in relative terms…and thus near zero economic activity.

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  12. I have no problem with what you are saying but cannot make my brain function properly without doing my own double entry accounting ledgers to convince myself nothing is missing. (And I do not have time now so will have all these nagging doubts.)

    I agree that public debt is essentially the creation of "permanent" money because public debt is seldom repaid but rolled over and expanded with further deficits. I agree that private credit debt is self-limiting (and temporary) because it must be repaid with future income and therefore retired.

    Where I have a problem is specifying the interface between public debt and private credit. How much of public debt is actually financed out of private credit? Isn't all sovereign debt held by the public either private credit issued to the government (and thus an expansion of money in use) or private savings "stored" with the government (and therefore has no effect on money in circulation)?

    To be sure the last point is clear, I am arguing that private savings stored with the government is money taken out of circulation to be respent by the government - therefore net change of money in use is zero.

    I am just hung up on my lack of "grasp" of the accounting ledger. How much of the expansion of sovereign debt (deficits) is funded by bank credit? If money supply is to expand it seems there must be expanded bank credit. It can't all be private savings "lent" back to the government because that expands nothing.

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  13. By the way, I am putting this post on a Reading List for later this week at Global Economic Intersection. It would be great if Steve Keen got this discussion as a thorn under his saddle because he has become (through trial by fire) a foremost expert on the double entry accounting ledgers of our modern money systems. Scott Fullwiler is another person from whom I would love to read comments. And Marc Lavoie. Apologies to the others I have left off this short list such as Steve Randy Waldman, Cullen Roche and Mike Sankowski.

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  14. Paul, thanks; I will ruminate.

    Lounsbury: "I am arguing that private savings stored with the government is money taken out of circulation to be respent by the government - therefore net change of money in use is zero."

    I would argue something quite the opposite. I think of the money as already in savings, and the government offers tries to tease that money out of savings to buy T-bills or whatever... The objective of the government policy being to put the money back into circulation. I think the Q of M in circulation increases by this.

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  15. "cannot make my brain function properly without doing my own double entry accounting ledgers to convince myself nothing is missing"

    John…full disclosure… I don't base my analyses on accounting, They are based on the principles of circuit analysis and closed system theory, things that I learned as an engineering student and which I have always relied on in solving real-world problems.

    That said, I am fully confident that the techniques are in harmony with accounting. Further, I am familiar with accounting and bookkeeping practices in the broad sense, since I had a general contracting business and did my own bookkeeping. As with anything I do, I made it my business to learn at least the fundamental principles. I don't like relying on others for critical tasks.

    "How much of public debt is actually financed out of private credit?"

    None.

    I see that we are coming to this discussion from very different perspectives. I am sympathetic to MMT, because it is based on principles (mathematical and system) that are fundamental to understanding how things work in the Universe. Other seemingly unrealated systems are bound by the same mathematical patterns and constraints. These patterns are repeated in virtually every system that exists in the real world.

    2nd Law of Thermodynamics
    Entropy
    Definitions of closed systems, open systems, bound systems, conservation of mass and energy, etc.

    In my view of the world public debt isn't financed…the money is created out of thin air by the authority of the Constitution. Per the Constitution Article 1 Section 8, Congress is the only entity empowered to create state money. Neither the Fed nor the Treasury "creates" money, any more than the paymaster of a corporation creates the money it spends paying bills.

    Why do we pay interest on bonds held by the public? It was a choice made by politicians some 100 years ago, the reason doesn't matter, anyone familiar with how the government works these days must be aware that it has always been this way…paying interest to bankers (mainly) on money already printed is a blatant give-away to banking interests. Not a constarint on the system. No surprise that the system was set up this way.

    Also no surprise that the government ignores these laws when it is convenient to do so.

    Further, in order to borrow money from private sources, the money had to already exist…no money exists until the government spends it. This is a logical constraint that eliminates the possiblity that the government must borrow to spend. The government spends first, obtains tax revenue later, creates money first, then pay interest on previously created money.

    If the government had to borrow to spend it would dictate that taxes came first. Simple but very few see it.

    As a final thought on this subject, if the government had borrowed all of the funds it had spent into the economy, why is the sum of all deficits (positive and negative) over history greater than the Debt Held by the Public by some $1.6T? In other words there is $1.6T (at least, because some spending has been off-budget) in net dollars in existence not issued as debt.

    Where did that come from?

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  16. "I am arguing that private savings stored with the government is money taken out of circulation to be re-spent by the government - therefore net change of money in use is zero."

    I'm with Art on this.

    The funds were already saved (accumulated as wealth) and already removed from circulation. Now these rich folks need a sugar daddy to pay them interest on it . Selling bonds removes nothing from the economy…it was already gone. It's a gift to monied interests… it has no bearing on the functioning of the system.

    The government creates new money when it spends…there is no reason to "borrow" that which it had to create prior to the "borrowing". To argue otherwise is to ignore logic (and The Arrow of Time).
    Savers of large sums have no choice but to invest in bonds…there is no investment in the known universe as safe.

    Money remains in "circulation" for roughly one spending cycle…it's a straight line not a circle…during each budget cycle virtually all public spending and all spending that results from credit issuance is accumulated and saved (disproportionately at the top end of the income spectrum).

    It's not unlike a poker game. Eventually someone (or two) win most of the money in play…the game reaches a point where it can't go on, partly because the "losers" can't afford to play and partly because the stake isn't high enough to motivate the "winners" to continue.

    The winners aren't about to stake the players to continue…the potential gains are out-weighed by the risk. They rely on someone else to provide the stake. A"sugar daddy".

    In the economy, it's public spending that provides the stake but there are also "suckers" that will borrow money to do it, hoping they will "win big".

    So in the end, banks have a "toll gate" on all sources of the money creation that drives capitalism. They earn interest on government bonds issued along with government spending, and they earn interest as a result of lending us our own money.

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  17. Paul,

    you said:

    "if the government had borrowed all of the funds it had spent into the economy, why is the sum of all deficits (positive and negative) over history greater than the Debt Held by the Public by some $1.6T? In other words there is $1.6T (at least, because some spending has been off-budget) in net dollars in existence not issued as debt. Where did that come from?"

    Where did you get the figures to reach that conclusion?

    Does this $1.6T exist as money (cash, deposits) or in some other form, do you think?

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  18. Phillippe

    I just added up all of the deficits (±) over history.

    The data is available at Treasury.gov in one spreadsheet…here's a link to my copy…

    https://dl.dropboxusercontent.com/u/33741/debthist01z1.xls

    I should clarify what I mean by "cash", I use the mathematical context rather than the common meaning…cash is net dollars, i.e. dollars in the system that do not have an offsetting liability.

    Most "cash" in the system is offset by an offsetting liability…about $44T in private debt. It nets to zero.

    Currency, the common idea of what "cash" is…is not really dollars or fractions of dollars…it is a physical representation of the unit of account.

    A dollar (or fraction of in the case of coin) is an entry on a balance sheet in the non-government.

    When the government spends it marks up the bank account of the relevant agent, increasing the number of dollars in it's account. When it taxes it marks the numbers down. Dollars are represented on balance sheets as a number.

    There exists approximately $1T in currency/coins (physical money) last time I checked, maybe 80% coins.

    At any given moment the level of net dollars is the sum of deficits over history less Debt Held by the Public, by accounting.

    Total Net Financial Assets (NFA…state-issued) is the sum of deficits over history.

    "Does this $1.6T exist as money (cash, deposits) or in some other form, do you think?"

    I think it exists practically speaking only in an accounting context…there is no way to know on which/whose balance sheets (or wallets) it resides. The system is too big. It must be in some combination of currency and electronic form.

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  19. I get your point regarding the money 'supply', and I agree with it I think. Treasury spending creates new bank deposits.

    However, if you leave out government bonds as a form of money, over a given accounting period government spending only seems to increase the total *stock* of money if government bonds are bought directly at auction by banks.

    When banks buy bonds directly at auction (with reserves), the subsequent government deficit spending increases the quantity of bank deposits and thus increases the total money stock beyond what it was prior to the bond sale (all else being equal). If however the bonds are bought by primary dealers or by non-banks directly, then when the Treasury spends the amount of bank deposits will be the same as it was prior to the bond sale. There might be a reduction at the point of sale and prior to the spending, but then the spending will simply return the stock of money to what it was prior to the bond sale, again all else being equal. As such the deficit spending in this case doesn't really increase the overall stock of money.

    What do you think?

    Of course, if you count government bonds as money, then deficit spending does increase the overall money stock no matter how it happens.

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    1. I'd be interested to know what you think on this point, whether you think it's correct or not.

      The basic point being that whilst government spending creates bank deposits and "buying bonds with deposits" destroys deposits, if bonds are "bought with deposits" then government deficit spending simply returns the stock of money to the quantity that existed before the bond was bought, all else being equal.

      (I say "bought with deposits" because bonds are ultimately paid for with reserves of course).

      As a very simple example:

      Treasury: $0
      Banks: $100 reserves
      Non-banks: $100 deposits

      Total 'money stock' = reserves + deposits

      1. Treasury sells $100 bonds to non-banks directly:

      Treasury: $100 TGA deposit
      Banks: $0 reserves
      Non-banks: $0 deposits

      2. Treasury deficit spends $100:

      Treasury: $0
      Banks: $100 reserves
      Non-banks: $100 deposits

      Total 'money stock' is the same as before the bond was bought.


      Whereas, if the bonds are bought by banks:

      Treasury: $0
      Banks: $100 reserves
      Non-banks: $100 deposits

      1. Treasury sells $100 bonds to banks directly:

      Treasury: $100 TGA deposit
      Banks: $0 reserves
      Non-banks: $100 deposits

      2. Treasury deficit spends $100

      Treasury: $0
      Banks: $100 reserves
      Non-banks: $200 deposits

      Total money stock has now increased by $100 deposits above what it was prior to the bond sale.


      Do you agree?


      Delete
  20. "At any given moment the level of net dollars is the sum of deficits over history less Debt Held by the Public, by accounting."

    Is that equal to the quantity of govt bonds held by the Fed + the amount of currency created by the Treasury directly*?

    *i.e. mainly coins.

    Perhaps you could also add the amount of gold and foreign currency purchased by the Fed, as these purchases also add to the quantity of 'net dollars'?

    Thanks

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  21. Phillippe, I'm not an expert on monetary operations (as far as the closed system defined as the non-government they are irrelevant other than wrt accounting minutia), but this is my view of the system…

    "1. Treasury sells $100 bonds to non-banks directly:"

    I'm pretty sure only primary dealers are able to buy bonds directly, using reserves, not deposits. Ordinary banks or non-banks can only buy on the secondary market, ie securities that already exist. Thus, ordinary banks and non-banks don't affect NFA.

    When the Treasury spends it always increases the number of net dollars in the non-government. When it issues bonds, it is an asset swap…bonds for dollars…so that operation affects no change in NFA.

    The net result of government spending is always an increase in NFA and a change in the composition of NFA (bonds and dollars).

    Any operation by the Fed is an asset swap that can only affect securities that already exist. The Fed is only allowed to buy/sell securities and/or alter the term structure of said securities and re-issue them. There is never an increase in NFA from Fed operations (reserves are not NFA).

    So, to summarize, Treasury spending creates flow and increases the level of financial assets in the non-government, Fed operations only involve asset swaps. The Fed can't buy "stuff", there is no net change in NFA.

    I don't know how gold purchases fit into the picture but I highly doubt the transaction would change the level of NFA. The Fed is pretty much forbidden to do this. It's possible there are exceptins I don't know about.

    This is a response to your previous comment…it may change the parameters of your last comment so i will leave that one for now.

    Rsp
    Paul

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  22. Briefly:

    Total credit 'market' debt is somewhat unknowable ... it has to include non-performing loans held off-balance sheets, shadow banking plus over the counter credit-, currency- and interest rate derivatives. Dollar debt is more likely to be near $1 quadrillion of which government- and listed debt market borrowings together represent a very modest fraction of the total amount.

    Everything depends of course which ledgers you use for your accounting entities. For example, Federal Govt borrowing = service cost of listed public + private sector debt.

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  23. Paul,

    "The statement often made in blogs and news articles is that 90% or more of the money in circulation is private debt, the rest coming through net government spending, so clearly credit (debt) must be the main driver of the system."

    No, this is NOT how the 90% figure is derived. It is the difference between base money in circulation (i.e. notes and coins, not bank reserves) and the sum total of broad money from all sources in circulation. This has nothing to do with government spending. It is simply the difference between state money created by central banks and state money created by other agents. Bank reserves are excluded because they are not "in circulation" in the economy as a whole - they remain within the banking system at all times unless they are converted to physical currency.

    Government spending is indeed the principal driver of the economy. In most Western economies, government spending is somewhere between 40-60% of GDP, which is consistent with the figure that you have come up with for the proportion of money circulating in the economy that is derived from net government spending.

    I fear you have confused the driver of money circulation - the pump, if you like - with the mechanism by which money is actually created. Even though government spending drives the economy, actual money creation is delegated firstly to the central bank (base money) and secondly to commercial banks (broad money). Bank-created money and government-created money are fully fungible and for all practical purposes indistinguishable.

    I do think you need to be a little careful with your assertion that governments "create" money when they spend. Theoretically this is correct, but it does depend on the legal constraints that governments impose on themselves! The US government can spend in advance of tax receipts or debt issuance, because it can run an overdraft with the Fed. This is in effect money creation by the Fed. But governments in the European Union can't do this. It is explicitly forbidden under the Lisbon Treaty. They have to receive taxes and/or issue debt in advance of spending.

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    Replies
    1. "Government spending is indeed the principal driver of the economy. In most Western economies, government spending is somewhere between 40-60% of GDP"

      No. Take France for exemple. Gov. spending is equal to 57 % of GDP (half of it is in fact redistribution or income transfer). But in the same time, non-financial firms spend 100 % of GDP or households spending (final consumption) is equal to 50 % of GDP. If you add every spending by all sectors of the economy, the total number will be somewhere between 300 or 400 % of GDP.
      57% of gouvernement spending doesn't mean 57% of economic added value. The real economic value added by the french government is around 25%.of GDP (http://www.insee.fr/fr/themes/comptes-nationaux/tableau.asp?sous_theme=1&xml=t_1101).

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