Monetary Realism

Understanding The Modern Monetary System…

The Fed and Treasury’s “Symbiotic Relationship”

It’s certainly not the most destructive myth in the USA (this is), but definitely one of the more pervasive ones – this idea that the Fed is entirely independent of the US government.  But a new paper from the NY Fed sheds light on what they call a “symbiotic relationship”.  A close look at the management of government funds during the financial crisis shows that this debate about independence is largely semantics.  Operationally, the Fed is very much an agent of the government or as I often like to say – the other pocket in the same pair of pants as the US Treasury.  But don’t take it from me.  Take it from the Fed officials themselves:

“The U.S. Treasury and the Federal Reserve System have long enjoyed a close relationship, each helping the other to carry out certain statutory responsibilities. This relationship proved benefi cial during the 2008-09 fi nancial crisis, when the Treasury altered its cash management practices to facilitate the Fed’s dramatic expansion of credit to banks, primary dealers, and foreign central banks.

…Understanding the relationship between Federal Reserve credit policy and Treasury cash management is important because the relationship illuminates an important but sometimes unappreciated interface between the Treasury and the Fed. It also underscores the symbiotic relationship between the two institutions, in which each assists the other in fulfilling its statutory responsibilities.”

MMR views the world in a similar light.  As an agent of the US government the Fed is essentially a partner in helping the US government achieves its objectives.  In this regard it is very much a part of the US government.  There’s no point denying it.  Even the Fed knows this relationship is symbiotic and they’re explicit about it….

About

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering asset management, private advisory, institutional consulting and educational services. He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance and Understanding the Modern Monetary System.

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135 Responses

  1. Robert Rice says

    FYI, the TC rule is relatively consistent with my analysis. It calls for an extra trillion of spending/deficits given projected quantities. More evidence as to why 1.7 trillion per year will not cause hyperinflation in a “world ending”, bond dumping catastrophe:

    http://monetaryrealism.com/the-tc-rule-for-fiscal-policy-screams-lower-taxes-and-more-spending/

  2. Vincent Cate says

    One more thought. I can find hyperinflations without war, and some without corruption, and some without regime change, and some without foreign debt (at least till after hyperinflation started), and some without any other particular problems that MMR claim cause hyperinflation before it started. However, they always have the ability to print their own money, large debt (lots short term), and large deficit before hyperinflation can start. Think about that. To me it makes it look like the other things are not the key, but that printing, debt, and deficit are. Back when people used gold and silver coins as money there were wars, and regime changes, and foreign debts, but not hyperinflation.

    If Spain or Greece leaves the Euro and starts printing money they would probably be ready to start hyperinflation right away. All they are missing at the moment is the ability to print their own money.

  3. Vincent Cate says

    Dan M.
    I don’t know how many other ways I can say it… REAL problems cause hyperinflation… not some magical debt/GDP threshhold. It takes a imperfect storm of production collapse, money-printing, corrupt government, foreign obligations, and societal breakdown. Only one of those is happening, and not that much faster than we sell our currency to foreigners. You haven’t shown us an example of currency mismanagement without those other factors resulting in hyperinflation.

    I think we are repeating now, so maybe it is time to stop. I think hyperinflation is correlated with all those problems and that the US will get them if/when it gets hyperinflation. But to predict hyperinflation the debt/GDP and defict/spending ratios seem the best way I know of. How would you know if the level of corruption in the US is getting to danger levels? Does our oil use count as a foreign obligation? All the military bases that pay for all kinds of local support, is that a foreign obligation? We have the money-printing. In hind sight these problems will be clear. There will always be these problems in hyperinflation. So how could your theory be falsified? How can you predict anything? My math for hyperinflation is far more scientific than what you have.

  4. Dan M. says

    Vince,

    That “bill” that came due that I was speaking of was a debt. I don’t think the velocity of money is considered increasing as financial assets are traded for other financial assets (or used to pay down financial liabilities)… I’m quite sure it only applies to dollars being used to purchase consumption & investment. Our bills that DO represent velocity (cell phone, cable, even food, etc) don’t seem to be having any production constraints… i get ad’s for them to supply me more all the time. Our nation is able to provide what people demand, and we’re still under capacity.

    The rest of your post is just explaining how hyperinflation is hard. I’m sure it is. I get that. What we’ve been trying to show you over and over again is that it’s a mess of circumstances that combine and compound to make hyperinflation such a mess, very few of which even come close to applying to the U.S.

    I don’t know how many other ways I can say it… REAL problems cause hyperinflation… not some magical debt/GDP threshhold. It takes a imperfect storm of production collapse, money-printing, corrupt government, foreign obligations, and societal breakdown. Only one of those is happening, and not that much faster than we sell our currency to foreigners. You haven’t shown us an example of currency mismanagement without those other factors resulting in hyperinflation.

  5. Vincent Cate says

    Dan M.
    […] but when our liabilities overhang our assets, we don’t care about moneyness, we care about the equity balance and debt service ratio. This is what keeps most Americans up at night… the 3 months of emergency fund they have, two kids going to college, and a job they might lose. What’s important is that our balance sheets are too WEAK, and we need more dollars to service them. If we have a liability overhang AND we think we might lose our job or already have, then we DEFINITELY don’t care about the “moneyness” of these assets, because we NEED these to pay our debt overhang.. in fact, in times like this, we actually value moneyness, […]

    In this situation when your 3 month bond comes due, instead of buying another that yields 0.05% you just keep the cash. In this situation where money is tight it is often the case that as soon as money comes in you pay it out to some outstanding bill. The velocity of money goes up. When you are tight for money you don’t put your money in bonds but get out of bonds. Note that as Germany went into hyperinflation most everyone seemed to think they needed more money.

    As you go into hyperinflation people become poor. A 30 year bond becomes worthless. Most financial assets become worth far less (at first even stocks and bonds because interest rates are so high). It seems like you think people need to be rich to have hyperinflation but in real terms they always seem to be poor in hyperinflation. Their balance sheets get wiped out. Prices go up far faster than their income. They don’t have enough cash to live like they used to.

  6. Dan M. says

    Vince,

    MMT/MMR doesn’t state that the changing of the “moneyness” on someone’s financial balance sheet can’t be inflationary, but simply that it’s only one small consideration.

    The reason we talk about balance sheets so much is because there are liabilities on those balance sheets (mortgages, student loans, etc) that have to be serviced by both our work and the assets on our balance sheets. Can you visualize this for me? A bunch of assets on a balance sheet, varying from pure money to kinda money to not money… and a corresponding bunch of liabilities, that need to be serviced by our jobs and our assets just mentioned.

    When our liabilities are super small, we might be inclined to care quite a little bit about the “moneyness” of our balance sheets, and therefore changing our bonds to money might matter somewhat to us and get us putting our money to work by buying or investing… but when our liabilities overhang our assets, we don’t care about moneyness, we care about the equity balance and debt service ratio. This is what keeps most Americans up at night… the 3 months of emergency fund they have, two kids going to college, and a job they might lose. What’s important is that our balance sheets are too WEAK, and we need more dollars to service them. If we have a liability overhang AND we think we might lose our job or already have, then we DEFINITELY don’t care about the “moneyness” of these assets, because we NEED these to pay our debt overhang.. in fact, in times like this, we actually value moneyness, because then there’s no question as to its liquidity… just in case the bank doesn’t want to take our 3 shares of Apple stock as a mortgage payment :).

    It’s MUCH MUCH more about balance sheets than it is about “moneyness.” Once you visualize that the way I do (assuming I’m correct, which I think I am), I think it will click.

  7. Vincent Cate says

    Dan M.
    So we agree on the sliding scale of moneyness…

    A sliding scale means some things are not exactly like money. So if the Fed makes some new cash (100% money) and buys up a 30 year bond (our least moneyness bond) then things have changed some. And if things have changed some it could be inflationary. I have yet to see a study of historical monetizations that concludes monetization is not inflationary.

    As for most of the government bonds being short term, that seems to be typical right before hyperinflation. :-) It makes it easier to have a sudden flood of 100% money.

  8. Dan M. says

    Vince,

    We may be converging here… I like your term “moneyness.” I don’t like the term post-dated check, though, because that implies a lak of purchasing power until */**/****.

    That said, a post-dated check actually is a good point in some ways. Putting aside legal tender laws for a second (which I think there is a general lack of understanding of by Keynesians & austrians alike), could you go buy a car with a post-dated check written to you by the government of the US? I think you could. If not, probably more out of the confusion of the finance department as to how to handle it :).

    So we agree on the sliding scale of moneyness… but keep in mind, in a world of 1’s and 0’s, a LOT of things act as money nowadays. If some tech giant wanted to buy your startup business from you, it’s likely they’d use a stock swap. I also wouldn’t be surprised, although conveninence of dollars makes it somewhat pointless, if at some point you could buy everyday goods using any type of common financial asset. Why couldn’t you use your S&P 500 stock index fund to buy groceries… just have your credit card manage the details of the transaction. It’s messy for a host of reasons, (taxes, the need for the grocery store to manage a portfolio of money they receive, etc), but in a modern economy it could probably be managed.

    I’d also add, lastly, that short-term treasuries (which make up the bulk of our debt), are about as close to pure money on the “moneyness” scale as you can get. That, and I think you still need to focus more on financial balance sheets, which I tend to think drive our decisions much more than where on the “moneyness” scale our financial assets lie.

  9. Vincent Cate says

    Dan M.
    I don’t think MMR/MMT says that monetization can’t be inflationary, but simply that it’s very unlikely to drive inflation and is only a small contributor to velocity, especially in today’s environment.

    There is another thread with the title “Does Anyone Actually Know What MMT is?”. I think MMR suffers from some of the same problem. I think it would be nice if there were a sort of “party platform” or detailed FAQ. From this you could have threads of debates linked to or hanging off of parts of that sort of like a FAQ. And from time to time maybe the platform changes if the consensus changes.

    As I understand most MMR people think, like MMT, that “bonds are money” and so making new money to buy bonds, which from the publics view is converting bonds to money, or monetization, does nothing. If this is not true I would be happy to hear it. :-)

    I think the truth is a bit more fuzzy than “bonds are money” or “bonds are not money”. There is sort of a sliding scale of “moneyness”. I think that the view of bonds as a “post dated check” that will turn into money is good. The shorter the time you have to wait till it turns to money the more it already acts like money. I think this is a clean and accurate way to think about it. The average person can relate to this and understand it. It seems clear that a check that is payable tomorrow is very much like money and one that is payable 30 years off is much less so (given the uncertainty about interest and inflation rates over such a long time). And in this view this all seems so clear.

  10. Vincent Cate says

    Robert Rice
    You are not representing your argument correctly. This isn’t a question of real versus imagined as you suggest. Your argument is:
    P: If it hasn’t occurred, it won’t/can’t occur.
    P: It hasn’t occurred.
    C: Therefore it won’t/can’t occur.
    And I’m rejecting your first premise–it is false–while asserting the second is irrelevant. Whether it has or hasn’t occurred previously is an interesting historical footnote, it is not however a litmus test for a sound argument. An argument is sound if it is valid and has true premises. You’ve failed to point out invalidity or false premises in my arguments. Whether what I’m proposing has occurred historically is interesting trivia and nothing more.
    And this idea that it hasn’t occurred therefore it won’t or can’t occur is self-refuting. The writing of this very claim at some point in the past was a new event demonstrating events which haven’t occurred previously do occur.
    If the first premise above were true, nothing would have ever occurred. Quite obviously events occur. To avoid this, you would have to believe in some kind of infinite regress with no beginning where all current events are merely reoccurances of past ones. Certainly nothing new under the sun would have ever occurred. But new events have and do regularly occur, agreed? Where does the saying, “There’s a first time for everything,” originate if not from an observation that new events occur?
    Focus on the validity of the arguments and the truth value of the premises, not on the historical footnote.

    I am not sure which comment you are responding to. Are you saying that even though nobody else has ever been able to monetize a large debt without getting inflation “there is a first time for everything” and maybe the USA will be able to?

  11. Vincent Cate says

    JK
    I don’t think anyone is arging that the reason the U.S.Gov “came up” with bonds is so that people have a safe place to save. A more accurate way to say it is the U.S.Gov responds to the non-government sector’s desire to save by offering bonds.
    […] Therefore, the desire to save must come first. Right?

    Don’t really see much difference. I don’t buy the idea that bonds do nothing for the government/demand/inflation and are just satisfying peoples desire to save.

    People were saving long before there were central banks or government bonds. Government bonds are not required for people to save.

  12. JK says

    Vince, I’m confused about this statement: “But I don’t believe that bonds are just something the government came up with so that people would have a safe place to save money or that bonds have no impact on inflation.”

    I don’t think anyone is arging that the reason the U.S.Gov “came up” with bonds is so that people have a safe place to save. A more accurate way to say it is the U.S.Gov responds to the non-government sector’s desire to save by offering bonds.

    For example, imagine hypothetically if no one desired to save in financial assets. Then there would the U.S.Gov would see no “buyer” when it tried to sell bonds.

    Also, issuing bonds (I think) began in a monetary regime where borrowing money was necessary in order for the U.S.Gov to spend (beyond tax revenue). It’s the transition from that monetary regime to fiat currency that has changed the “nature” or “purpose” of bond sales. But nevertheless, in both situations, the U.S.Gov could not have issued bonds unless the non-government sector had a desire to save. Therefore, the desire to save must come first. Right?

    As for bonds effect on demand-pull inflation, it seems you are ‘sort of’ correct… in that any time money is not spent into the economy it has an anti-inflationary effect.

  13. Vincent Cate says

    First, let me say thanks for all the time you have put into this. It has been very interesting.

    I feel like MMR is trying to have it both ways on bonds. First, they will say bonds don’t fund the government. Then they will say, you can’t think of them as burning the money they get from selling bonds. Well, this seems a contradiction. So I don’t feel happy with the MMR answer at the moment.

    I think you must have a consistent world view for it to make sense and be able to predict the right results. I think it is reasonable to view bonds and taxes as funding the government and printing money as the source of inflation. I also think it is reasonable to view the government as having an unlimited ability to print currency and only needing taxes and bonds to control inflation.

    But I don’t believe that bonds are just something the government came up with so that people would have a safe place to save money or that bonds have no impact on inflation. There is lots of experimental evidence that does not fit with that view.

  14. Dan M. says

    I see what you’re saying, Vince, but I think it gives you the entirely wrong image of what it will do to the economy. Simply put, financial balance sheets drive habits much more than the legal tender status of those items, especially when we’re simply talking cash vs gov’t bonds.

    This is why it’s important to not visualize it as you do… simply put, things called “financial assets,” and their make-up on our balance sheets, drive our wealth/decisions MUCH more than what we may or may not agree should be referred to as “money” on those balance sheets.

    Does that make sense?

  15. Vincent Cate says

    Dan M.
    I think you just might be…. here’s why that’s not the right view.
    When taxes are paid by the end of the year, people don’t look at the money they’ve put into taxes and say, “well now I can use this amount at a later time.”
    They have no purchasing power based on the taxes they paid. They can’t make any choices as a result of those taxes regarding consumption. They’re no richer for it, nor do they feel like they are.

    I understand that bonds are different than taxes. But I still think we can reason about them my way better.

    Imagine that when the government gets a bond it burns the money and issues a post-dated stimulus check. These stimulus checks will be a bit like money but not exactly. The closer in the date the more like money. When the date comes up on the stimulus check the person can get regular money.

    How would it be “wrong” to think about it my way? It seems more consistent or “in the spirit” of how MMT/MMR think about taxes. It also seems easier to understand reality correctly when thinking about it this way. In the same way that “the purpose of taxes is to control inflation” becomes clear when you think “the government could burn the tax money”. If you think about bonds this way it becomes clear they help control inflation.

  16. JK says

    Robert,

    Thanks for responding to my question about which fallacy. I’m really not sure which part of his argument I was talking about. I guess what I am feeling is that Vince is setting up the scenario (or definiing his evidence) in such a way that supports his conclusion.

    Meaning: his conclusion is a foregone conclusion becasue of the way he explains the supporting evdence (regardless of inaccuracies, etc). Maybe that’s not a specific logical fallacy.

  17. Robert Rice says

    Which as I noted last night means a net increase of NFAs into the economy of 1.7 trillion per year over your three year horizon. This is a little over 10% of GDP. Do you think that is a sufficient quantity of money in an underproducing, underemployed economy to create hyperinflation? There’s no way, particularly when you factor in what will happen to lending in your scenario with the skyrocketing interest rates.

    And to be clear I don’t think we’d need to raise taxes on just bondholders.

  18. Dan M. says

    I think you just might be…. here’s why that’s not the right view.

    When taxes are paid by the end of the year, people don’t look at the money they’ve put into taxes and say, “well now I can use this amount at a later time.”

    They have no purchasing power based on the taxes they paid. They can’t make any choices as a result of those taxes regarding consumption. They’re no richer for it, nor do they feel like they are.

    However, when someone buys a bonds, they’re choosing to save it and look at it and count it as part of their balance sheet. This savings in uber-safe money-like assets (even if it were in corporate bonds, or stocks) will change their purchasing power. This will affect their financial balance sheet. They may not be able to actually spend the bonds at the grocery store, but if our world ever got so weird that peoples’ liquidity was actually being disrupted by having too many bonds and not enough cash, the markets would adjust.

    In fact, watch Heat or Die Hard and you’ll notice that Bonds & money are really quite interchangable.

    So there are huge differences there. In one instance, financial assets disappear. In another, they remain on our balance sheet, and affect our future purchasing decisions.

    To build on my previous example, if the treasury initiated 1 year treasury bonds in the amount of $20,000 for every individual in the country, we wouldn’t see zero increased demand until a year from now, and then see hyperinflation… we’d likely see the inflation pretty quickly. Why? Balance sheets, not liquidity (or some ancient version of that word) really drive our decisions.

    In fact, If every household (not person) were sent a check and/or T-Bills of $20,000, creating $2.3 trillion in additional national debt, I don’t think that’d be the worst thing that could happen…. and I don’t think there’d be much of a difference in our purchasing habits depending on whether it was the bonds or the money.

  19. Vincent Cate says

    I like the view that the government can print all the currency it wants so we can reason as if they burned any taxes collected. Am I the only one that thinks the same logic should be used on bonds so that we can a consistent view?

  20. Dan M. says

    VC,

    I don’t think MMR/MMT says that monetization can’t be inflationary, but simply that it’s very unlikely to drive inflation and is only a small contributor to velocity, especially in today’s environment.

  21. Pierce Inverarity says

    “It is certainly different having the word reserve currency.” False. See Japan, the last 30 years.

  22. Vincent Cate says

    Robert Rice
    And btw, I already answered how the government could use the money to fund the deficit. Increase taxes. I’m not sure what’s difficult to understand here.

    So you are going to increase taxes on bond holders and take half of the $10 trillion that is owed to bond holders so you have an extra $5 trillion?

  23. Robert Rice says

    I’ve noted a number of his errors, from informal fallacies (e.g. his red herring fixation on the historical record, etc.) to a belief in false premises (e.g. inflation is not the inherent effect of money creation, etc.). As far as your concern over a formal fallacy–which argument of his specifically do you have in mind which you are concerned suffers from this? I can tell you whether there is a problem with the argument’s form from there.

  24. Vincent Cate says

    Dan M.
    But you have to get us to a point where “peoples’ savings is dropping in value FAST.” You haven’t gotten us there yet…
    […]
    I think this all comes down to us being the world’s reserve currency, […] as we almost should be considering other country’s GDP in our “debt-to-GDP ratio,” as their economies are really included in the activity and savings base that makes for a ton of demand for US dollars.

    If hyperinflation happens it is because of positive feedback. Look at the following URL for some of the feedback issues. These can start out slow and pick up speed over time. We might already be in some of these.
    http://pair.offshore.ai/38yearcycle/#hyperinflationfeedback

    I like the argument that we should include other countries GDPs in the debt to GDP ration. It makes sense. Certainly for countries that peg to the dollar or that use the dollar. Where I am in the Caribbean we have an “East Caribbean Dollar” that is pegged to the dollar. As long as oil is priced in dollars there will be lots of demand for dollars even outside the US economy. It is certainly different having the word reserve currency.

    My prediction of hyperinflation for the US dollar is with much less certainty than my assertion that MMR is wrong when it claims that monetization is not inflationary.

  25. Robert Rice says

    The equation of exchange is the quantity theory of money formulated into an equation. They are one and the same.

    And you completely missed the point on holding the velocity of money constant.

    Anyway, look, it seems apparent you are unwilling to acknowledge any error.

  26. Robert Rice says

    I already answered this.

  27. Robert Rice says

    And btw, I already answered how the government could use the money to fund the deficit. Increase taxes. I’m not sure what’s difficult to understand here.

  28. Robert Rice says

    Well, there’s no reason to look at it that way except as a self-serving exercise to support your thesis.

  29. Dan M. says

    1) Lowering the reward for holding fiat assets (plus giving them “legal tender” status) increases V(elocity).

    2) Increase in V tends to cause additional increase in V.

    3) High quantity of M tends to cause increase in V.

    Conclusion) High quantity of money and liquidating US debt causes V to expand at such an exponential rate as to create hyperinflation.

    Something like that?

    Not entirely untrue, though not taking into consideration all sorts of other considerations of the nature of the private sector.

  30. Dan M. says

    I wonder if you added the GDP of all the countries that use the US dollar to a modified Debt/GDP ratio and Deficit/GDP ratio, what we would come up with.

  31. JK says

    Can anyone out there put their finger on which logical fallacy this is. It’s something like “putting the cart before the horse” or maybe “making a circular argument” or something…

    It’s like he’s assuming A, so therefore A. (or something like that)

  32. Dan M. says

    Vince,

    But you have to get us to a point where “peoples’ savings is dropping in value FAST.” You haven’t gotten us there yet… you simply state that we’re already there and it’s all self-fulfilling doom at this point. People are losing about 2-3% per year by holding cash & even treasuries. However, these people not only have the option to buy corporate bonds, munis or stocks, which can fund real growth & wealth creation, they also have only a few months of savings before their home might be foreclosed on.

    The default risk due to most people’s lack of savings is a much bigger consideration than inflation risk on the little savings they do have. I think this all comes down to us being the world’s reserve currency, and the fact that even though our gov’t has printed tons of NFA’s, too many of them are sitting on overseas balance sheets and not enough in our checking/savings accounts. This will keep demand for money quite a bit higher, as we almost should be considering other country’s GDP in our “debt-to-GDP ratio,” as their economies are really included in the activity and savings base that makes for a ton of demand for US dollars.

  33. Dan M. says

    V would tend to increase somewhat because there’s usually less of a benefit of holding an asset that issues less interest. However, this is all relative to peoples’ disposable incomes, debt-service considerations, and balance sheets. Right now we have a really high debt overhang that people are trying just to service, much less pay down quickly. When debt service is tight, these are much bigger considerations to the demand form money in a society than whether you’re holding bonds vs cash on the asset side. It’s like saying that having extra airbags will cause us to drive more carelessly on glare ice next to the edge of a cliff… not really!

  34. Vincent Cate says

    Dan M.
    People save out of a will to consume in the future. Only after that decision is made, does the market react by providing savings opportunities that can return value. You almost seem to be saying that the bonds and their duration drive the will to save. This just isn’t how people operate.

    MMT/MMR has a story that the government just sells bonds because the people want to buy them. It is just not the whole picture.

    People save because they want their future to be better. But if the money is dropping in value fast they are better off buying things today. When things get really hard to where people don’t have but 2 months worth of living expenses if tuna is going up at 10% per month and their bank pays 1% per month their future is better if they buy extra cans of tuna, which they will eat, than just putting the money in the bank. This is the reality during hyperinflation. Banks don’t pay as much as the inflation rate. So putting your money in the bank makes you worse off. Not sure how to get this point across.

    Many times economists assume people act in their “rational self interest”. If you assume this then they buy things they will need in the future rather than put their money in the bank. This is what happens.

  35. Dunce Cap Aficionado says

    It is indeed symbiotic.

    But lets all remember, a parasite is simply a failed symbiote.