GSE debt doesn’t carry full faith of government: Treasury

8 Responses

1. Honestly – how do these morons get into high office? Being “close” to being backed by FF&C is like being “close” to pregnant…

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2. FYI, I tried to post this to the WSJ discussion of the Op-ed, but it wasn’t accepted. Written quickly, so not perfect, but gets at some of the same criticisms.

   Mr. Riedl’s article demonstrates an all-too common lack of understanding of the operational functioning of our flexible exchange rate monetary system, as do the overwhelming majority of the comments here.

   One of the above commentators did note, however, that an option available to the Treasury is to print money. The reality is, however, that the Treasury creates “money” WHENEVER it deficit spends, whether or not it sells bonds. Modern governments spend by crediting bank accounts; tax payments result in the debiting of the same accounts. A deficit is simply the crediting of more balances to these accounts than is debited; this necessarily raises the net financial assets of the non-government sector. A bond sale, on the other hand, has no effect on net financial balances of the non-government sector, as it is simply a trade of a non-interest bearing asset for an interest bearing one. The net result of both transactions, then is that a deficit by definition results in a net increase in the financial balances of the non-government sector even when bonds are sold—this is a fundamental truth of national income accounting that is true by definition. It is only under a commodity money (like a gold standard) or a currency board (as in Hong Kong) monetary system that a deficit results in an outcome that resembles the “loanable funds” and “crowding out” paradigm Mr. Riedl refers to throughout his article.

   Furthermore, consider how an actual purchase of a government bond occurs in our system. An individual desiring to purchase the bond will have balances debited from his/her bank account, while this individual’s bank (or the bank’s clearing bank) will actually carry out the purchase of the bond from its reserve account, since Treasury bonds can only settle via these accounts. But reserves used to buy these bonds are themselves placed into circulation when the Fed buys Treasury bonds that resulted from previous government deficits. In fact, shortly before Treasury auctions settle, it is well-known that the Fed engages in open market operations to provide the reserves to the financial system required for settlement of the auction. That is, the “money” used to buy bonds comes from deficit spending—or, otherwise stated, it is the deficit spending that necessarily comes first, before the bond sale. In our system, then, bonds do not finance government deficits; rather, government deficits PRECEDE bond sales.

   It is the sort of analysis provided by Mr. Riedl that is at the root of the current lack of sufficient aggregate demand in our economy, and it is the same sort of thinking that will keep us from emerging from this downturn anytime soon.

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3. Ooops–posted the above to the wrong story . . . sorry

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4. The following article may shed some light on the subject.

   http://www.npr.org/templates/story/story.php?storyId=5282521

   Whatever the mechanics are regarding debt issuance, political constraints remain.

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5. Hi Aaron–haven’t seen your name since Warren had his old bulletin board, if memory serves.

   Regarding this link , just want to note that it’s like fingernails on a chalkboard to me when I see the trust funds added to measures of the national debt. Even the mainstream theory of the intertemporal government budget constraint that’s in all the graduate macro/money textbooks would use the privately held debt only (including omitting debt held by the central bank), since the only debt that really matters is the debt that must be serviced. It baffles me that even the mainstream economists don’t correct this obvious error.

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6. Excellent memory Scott, good to talk to you again. New website is a great follow up from EPIC.

   I (of course) agree, but “debt ceiling” is why Kashkari is choosing “implicit support” vs. “full faith and credit”. Its a consolidation issue.

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7. Right . . . thanks for the link.

   Warren . . . looks like “eliminate debt ceiling” needs to be added to the proposal list, in order to reduce the spread above Tsy’s (and for many other reasons, too, of course).

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8. congress does that routinely as they approach it, though usually kicking and screaming and grandstanding. but it’s the same people who approved the spending so they don’t have all that much to say about hiking the debt ceiling

   kashkari is confused.

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