How Money is Created through Debt in our Fiat Economy -- Starting from Scratch

Cash (reserves) is physical use of money. Writing a check (or wiring money) effects an electronic transfer of reserves (cash).

While one is physical and other have electronic elements, the accounting effect on your bank (decrease of its reserves) is the same.

We can clear that up when we start talking about how the Govt selling bonds effects things.

Once we get clear on that, we can move on to other topics. It doesn't make sense to talk about macro issues when we hadn't even established what we mean by money and what happens to one bank when it makes a loan. If we never agree on definitional terms and what happens on the micro level with one bank, we will never reach an understanding on the macro level because we will not be operating from a common understanding.

That's why I've gone through this process in such painstaking detail.

 

Correct, a transfer from one bank to another and a net zero increase/decrease in the banking system as a whole.

Alright, we have come to the agreement that banks transfer reserves with each other and they interchange currency with reserves. Now what?

 

which is why when you talk about money that you spend what is really being spent is reserves.

That's right, because banks do not create reserves.

Now we can talk about what happens when the Govt borrows money.

When the a bank lends money to anyone, whether an individual or the government, the effect is the same. Reserves are transferred from the bank to the lender or payee, and new deposits are created, but no reserves are created.

If the bank buys a US treasury, the effect is the same. Reserves are transferred to the Govt and the bank gets the note, and new deposits are created.

If the bank sells the note to another party, the reverse happens: Reserves are transferred into the selling bank in from the buyer and the note is exchanged.

Thus, a bank buying a Treasury, in effect lending to the Govt, expands the total amount of deposits just like any other bank loan, but does not effect the amount of reserves in the system. Conversely, if the bank sells the Treasury, (effectively getting the loan repaid) the total amount of deposits decreases, but the amount of reserves stays the same.

It is different when the Fed buys a treasury. When the Fed buys a Treasury (or anything else), new base/cash/reserves are injected into the system. The opposite happens when the Fed sells a Treasury (or other asset).

 

If that's what you want to view it as. Then fine, it really doesn't change how the economy works.

Never said they did

This is where things get complicated and we really have to take it one step at a time rather than make generalizations. Banks only lose reserves when the Treasury calls upon their deposits from the banks.

http://research.stlouisfed.org/publications/review/79/10/Accounts_Oct1979.pdf

But, for generalized purposes I will agree with you that reserves are transferred from the bank to the Fed in the form of Treasury's deposit at the Fed? Do you agree with this?

And deposits are decreased by the same amount. The note is simply swapped with reserves

The amount of reserves increase.

I never said otherwise. I have repeated over and over that the Fed is responsible for making Government spending usable in the real economy by creating reserves. But they are not paying any one money. The deposits that have a claim on the reserves are created by either the Govt or the Bank. Not the Fed. The Fed only controls how many deposits the bank can make.

 

I was incorrect above. When the public pays for a Treasury from the bank, reserves are not created just deposits are decreased. That was an incorrect statement on my part.

 

Nothing we say changes how the economy works. We are trying to find an accurate description about how it works.

Explain exactly what you mean and tell me which page you are referring from your cite so I don't have to wade thru all 14 pages.

I don't understand the distiction.

Any time a bank transfers reserves to another bank, they are transferring deposits in the Fed. That is what reserves are, banks' deposits in the the reserve accounts in the Federal Reserve System.

I agree that the transfer of reserves to the Govt is the same thing.

Correct, as I stated in my next sentence.

No, because, as we have established, bank lending does not create reserves. It only creates deposits (you can now see why it was important to establish this basic understanding first).

Your statement is too broad and inaccurate.

We'll get there, don't jump ahead of it.

 

Reserves are not created or decreased regardless of who buys it, unless it is the Fed.

 

And PS, why this matters is relevant to our future discussion on Govt funding.

Because when you "spend" money to pay taxes, what is happening is a transfer or reserves (cash) from your bank (debiting your account) to the Govt.

 

Before we get in to reserve balances and the effect of TT&L Note accounts, let's go through this discussion first.

The Govt's account is at the Fed also. Reserves are converted to the Treasury's account at the Fed in which the Govt can now credit deposits through this account which puts reserves back in the system.

Never said bank lending creates reserves

 

We will assume this generalization for the broad portion of this debate. But this is highly complex area of how the system works.

This is what that paper I gave you from the Fed is about. How to prevent fluctuations in reserve balances. We can talk about it later, but basically long story short... your taxes stay in the banking system, in which banks can either use reserves against them or not... until the Govt needs to fund it's account at the Fed to disperse payments.

 

That's fine, there is not value bogging it down with details on specific that don't change the big picture.

But given the Govt is expending about $1.3 trillion more each year than it is receiving in tax revenues, my guess is those funds are not sitting around in account for a very long period of time.

 

The point is it doesn't matter if they are in the account or not. The point is the level of reserves. The Govt can spend what ever it wants regardless of how much tax revenue it is receiving.

 

Crediting that as accurate, how is that different than any bank's reserve account at the Fed? And what do you mean by "reserves are converted to the Treasury's account"? Converted to what?

Sources please.

 

You're getting ahead of yourself.

But like anyone else, the Govt can only expend the amount it has in reserves.

Otherwise we'd have no debt. And hyper inflation.

 

The Treasury has a Treasury account at the Federal Reserve. When banks pay for treasury debt, they transfer reserves in to this account at the Fed.

So reserves are essentially interchangeable with Treasury deposits.

 

So does every bank in the Federal Reserve System.

So does every other payment by a bank in the United states when it pays a check.

So is every other bank's deposits in the Federal Reserve system. Reserves at the Fed are the bank's deposit at the Fed. Same with the Treasury.

 

Yes

Nope, the reserves are lost when a check is written to the Govt. Reserves are not lost when checks are written in the private sector unless it is exchanged for currency.

Yes, what is the point?

 

If you are going to use words like "private sector" in your explanation, then you need to precisely explain what you mean by "private sector".

In the other thread you said the term was irrelevant to our discussion.

So we either have to agree what "private sector" means, and understand why it is relevant, or please rephrase you statement without using that term.

Then you can explain by what you mean "reserves are lost" and how they are lost and why that is different from any other reserves on deposit in the Fed.

The point is the Govt operates from an account at the Fed just like a bank does.

 

Fine, I will call it the "nonbank public". I will refer to banks as banks, govt as govt, and fed as fed.

When banks write a check to the Treasury, reserves are converted to Treasury deposits. The Fed's balance sheet is unchanged in this process. When the Treasury spends, reserves are put back in to the system and the Treasury deposit account is decreased. The Fed's balance sheet is still unchanged by this process.

In a sense yes.

 

All reserve held at the Fed are deposits.

What is a "Treasury deposit" at the Fed, and how is it functionally any different than a "bank deposit" at the Fed, if you claim it is.

Source please.

Since the Treasury spends out what it takes in, it washes out, right?

 

Technically they are both deposits in the Fed. So you are correct. The difference is Treasury deposits reduce reserves.

Correct in the sense that it takes in money in order to spend, not correct in the sense that the Treasury is limited in it's spending based on how much it has in it's account.

 

Here is a quote from the Federal Reserve...

Informing the public about the Federal Reserve
Is the Federal Reserve printing money in order to buy Treasury securities?

http://www.federalreserve.gov/faqs/money_12853.htm

 

That is consistent with what we've said all along.

The amount of reserves in the banking system does not change regardless of lending activity.

Only the Fed changes the amount of reserves in the banking system.

 

Yes, and the Treasury (aka the Govt)

 

So we are at the point where we agree that the Fed and banks have deposits at the Federal Reserve.

Treasury deposits are interchangeable with reserves.

So what next?