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

Third time, source please that this happens.

I could agree that if reserves were held by the Govt that would reduce the reserves held by the banks at the Fed, but not the overall amount of reserves in the system.

I'd be interested to see a source on that as well.

But from a practical point of view, if the Treasury only spends out what it takes in, what difference would it make?

In the end it's a wash. If the Treasury takes in $3 trillion reserves over a year but spends out $3 trillion in reserves over the same year, its a wash, there has been no change in the amount of reserves held by the banks at the Fed.

 

4th time, source please.

But ultimately irrelevant since the Treasury spends out what it takes in and therefore there is no change in the money supply by the Treasury.

It's no difference if reserves are transferred to a bank

 

http://www.clevelandfed.org/research/trends/2010/0110/03monpol.cfm

Treasury Deposits are not reserves in the system.

Correct... but there has been a change in the amount of deposits!

 

Did you mean the Govt and banks have deposits at the Fed reserve? I agree with that.

So are bank deposits. Again, reserves are deposits in the Fed whether banks or the Govt.

So we have established that banks do not create reserves, the Govt does not create reserves, only the Fed can create reserves, which it does based on monetary policy established by the FOMC.

Banks can lend which does not increase reserves, but does increase deposits.

And that is how money is created in the US.

 

Edit: OK, I see your cite.

That is intersting, and supports your claim about how Treasury deposits are not considered reserves.

It looks like what was happening in the end of 2009 in that article is that the Govt was selling a ton of debt and held it to have funds available to intervene and loan out because of the financial crisis, which is not the typical situation.

Here is a more recent chart on Treasury deposits at the Fed:



But what we are seeing is despite the short term increase in holding Treasury deposits, the overall amount of reserves held by the Treasury is relatively small compared to reserves overall.

How is there a change in deposits? You mean Treasury Deposits?

 

You like definitions so much. So I will correct you on this. Treasury deposits are not reserves

I have never said otherwise. But the point is the Fed increases reserves in order to handle Govt created money (aka deposit accounts).

I have said from the beginning that the Fed is required to created the money so we can make Government spending usable in the real economy.

This goes right along with what I have been saying the whole time.

 

Alright, let's do some T-Accounts to show how this works. A bank has $1000 in deposits and no loans.

Bank Balance Sheet
A | L
Ex Reserves $900 | Deposits $1000
Req Reserves $100

NOW, if the bank purchases a Govt debt in the form of a Treasury for $500. What happens?

A | L
Ex Reserves $850 | Deposits $1000
Req Reserves $150 | Treasury Deposits $500 (money Treasury can spend)
Treasury $500

NOW, the Govt uses this $500 to credit your account. For simplicity sake, say it is at the same bank. What happens???

A | L
Ex Reserves $850 | Deposits $1500
Req Reserves $150
Treasury $500

Notice how there are MORE deposits in the system created by the Government. Now that is the money used to purchase the Treasury from the bank off the secondary market. Which will reduce deposits in the system creating more excess reserves for the bank system to leverage.

If you do not agree on this, can you show me where I am incorrect.

 

That seems accurate, or at least, Treasury deposits are not counted as reserves. Reserves I suppose being only deposits by banks at the Fed.

What do you mean? What "Govt created money"?

OK, now we can discuss it.

How is the Fed required to create money so we can make Govt spending "usable" and what do you mean by that?

 

Deposits are money

Look at my post above. Govt creates deposits. These deposits affect the reserve ratios for the banking system. The Fed controls monetary policy in order to maintain an adequate money supply. So if Govt spending creates too big of a deficiency in reserve ratio for banks, then the Fed will increase the amount of reserves in the system in order to allow the banks to lend more.

So that ALL of us with deposits in the banking system can get access to our money.

 

Now Iriemon, take it to the next step. Now we are in this position where the private sector has $500 more in deposits and the banks are sitting on $500 treasury note.

A | L
Ex Reserves $850 | Deposits $1500
Req Reserves $150
Treasury $500

NOW, what if you take your $500 the Govt gave you and purchase a Treasury on the secondary market. Now what happens to the bank?

A | L
Ex Reserves $900 | Deposits $1000
Req Reserves $100

Notice how it just changes the reserve ratio by reducing the number of deposits in the system. It's all based on mathematics of people spending vs people saving.

The Fed's will increase the amount of reserves in the system based on the amount of money they want the banks to create.

 

How does that explain "Govt created money?" What is Govt created money, what kind is it, how is it created, and how is it different than Fed created reserves.

You mean the Govt pays out money which creates deposits?

But if (as is the normal case) the Govt pays out the same $$ it takes in, there has been no creation of deposits, right?

If and only if the Govt spends more than it takes in. Which it generally doesn't.

And not the Govt, since only the Fed create reserves. The Govt is a wash, it doesn't really create reserves but spends out what it takes in.

Why would it do that? If Govt spending increases deposits and reserves, that would improve reserve ratios for banks.

If the FOMC decides that is appropriate money policy.

Why couldn't we access it before?

 

LOL, after how many posts you've been (*)(*)(*)(*)(*)ing about discussing individual transactions, now that we are talking about macro economics you want to talk about an individual transaction?

That banks reserves increase. But *my* banks reserves decrease by the same amount and offsets it.

Plus, my reserves decreased when I sent the Govt my $500 check for taxes before it sent me the $500 payment.

Which is based on the money policy determined by the FOMC based on a whole host of considerations involving the economy and inflation.

 

Deposits are money that can be used in the real economy to purchase goods and services. Reserves can not be used for anything but transfers between banks and exchanging deposits for currency. But make no mistake about it, the deposits the Govt creates is MONEY for the private sector.

Look at the T-Accounts, when the banks purchase treasuries they aren't using deposits, they are creating "loans" and deposits. Banks buying treasuries is no different than banks loaning money to the nonbank public. They are leveraging reserves.

The Govt has run a deficit 95% of the time.

It creates deposits. The only thing the Govt does is affect the banks reserve ratio of reserves to deposits. But it is NOT a wash.

Well first it has to decrease reserves before it can increase reserves. So essentially the quantity of reserves is a wash, but there is a increase in deposits which decreases banks ability to lend.

Because if the Govt creates too many deposits and the Fed does not create enough physical currency, then banks would have a hard time making sure that the public has access to exchange it's deposits in to currency.

 

Don't get all mad, we've been doing good for a while.

What?

The Govt wouldn't issue debt for $500 if it had your $500 check for taxes

And?

 

Not necessarily. Deposits represent a claim on reserves, but it is the reserves that are transferred to make purchases.

Case in point as proof: In the Great Depression, before the FDIC, if there was a run on a bank, and you didn't get your money out, your were screwed. It didn't matter if you had $1 million in deposits, if the bank didn't have the reserves, you couldn't buy a cup of coffee with all those deposits.

Banks don't just transfer reserves for the hell of it. Reserves are transferred to effect payment for goods and services.

Do you mean when a bank, or a broker, purchases a Treasury? When a bank purchases a treasury, they transfer reserves like any other purchase.

It is just like any other loan, where reserves are transferred to pay the loan proceeds.

It's become a habit.

What creates deposits, and specifically how.

The fact that the Treasury Deposit is always positive contradicts your assertion.

Govt spending is a wash with Govt receipts and loans and doesn't create net deposits.

 

I'm not made, that's what the LOL means.

In your transaction, my bank's reserves decrease.

It issues debt and collects taxes simultaneous all the time. In your example, the Treasury was already issues and in the open market.

And the is what the FOMC makes its decisions to expand or contract the money supply upon, which is how the money supply is controlled and how money is created.

 

In what transaction?

What point are you trying to make. Exactly where was I wrong in my description of how banks purchase treasuries just like they issue loans. And the private sector first must receive the deposit before it can use their deposit to purchase the treasury. Show me where I was wrong.

No, they expand the money supply by creating reserves in the banking system. Reserves are never lent. Banks always have to keep the reserves the Fed gives them. The only thing the banks can do with reserves is transfer them amongst each other in the interbank markets or convert deposits to currency.

The Fed has nothing to do with how much money is in the economy other than controlling how much banks can leverage. The money supply increase happens from banks lending... not from the Fed giving the banks reserves.

 

Who cares, we do not have the same economic system we did in the 1920s.

Never said they did

Yes, they transfer reserves to the Govt who then transfers reserves back and creates a new deposit

Yes, banks loan money to the Govt and the Govt creates a new deposit in the system. There is MORE money (aka M1/M2 money supply).

When the bank gives the Treasury reserves in exchange for a note, the Govt then uses those reserves to create a deposit in the private sector. They pay the military... which increases money in the private sector and replenishes the reserves. This process reduces banks reserve ratio and they can now lend less money until the Fed turns some of the debt in to reserves.

Govt deficit spending is not a wash. That creates a new deposit in the system that did not exist before. That is CREATING MONEY!!

 

See bolded word.

The point I am making is that whatever effect you might argue that spending might have, it is washed out by receipts and monies it receives and thus has no effect on the money supply.

We can argue about whether they are "creating" and "destorying" reserves or transferring reserves in and out of its deposit account.

But either way, the reserves created or transferred in are the same amount as reserves destroyed or transferred out, that the net effect is -0-.

You've already agreed the Fed creates reserves. That has everything to do with how much money is in the economy.

Banks lend those reserves which multiply deposits, which does increase the money supply if you include deposits as money.

 

And the more money you put into an economy, the less it is worth.

 

If a bank uses it's assets (aka reserves), which is money that our deposits have a claim too. Then there is no deposit lost in the process of a Primary Dealer purchasing debt. Then when the Govt credits an account that is a NEW DEPOSIT. That is NEW MONEY. It is not a wash what so ever.

I never said that

Deposits are money

And the Govt spending increases the money supply also, if you include deposits as money.

 

But the more there is

 

The point shows that deposits are not like reserves, and that you can't spend deposits.

Just clarifying.

OK, just like any other bank loan does, no more or no less. Which as we know, does not change the amount of reserves in the system. (Now you see why we needed to go thru how the transactions work).

I agree that bank loans to the Govt will expand deposits just like a bank loan to anyone else. The key point is it is the bank lending, and not the Govt loan, that creates more deposits.

If the banks held a lot of Govt debt, that might be a significant point as to the amount of deposits create. But banks only hold only a small portion of Govt debt, and so it doesn't have a significant impact on the total money supply, and in any event, no more impact than the bank lending to anyone else.

Did you mean Fed reserves?

But when someone else gives the Govt reserves to by a note, no new deposits are created right? Because the money comes out of someone's deposit.

So when someone other than a bank holds Govt debt, no deposits (and no money) is created.

It is bank lending, not Govt borrowing, that expands deposits.

It is the bank that creates the "money" (deposits) through lending, not the Govt through borrowing.

If an only if the bank holds the Treasury are more deposits created, but again, no more deposits are created than if the bank lends to anyone else.

 

Only if you put in more than economic growth, and even then, other factors (bank lending, velocity) affect broad measures of the money supply.

 

Well this administration has pumped trillions into the system, while economic growth has remained almost stagnant, and banks arn't lending because very few businesses are willing to risk expanding because of the uncertainty of what anti business regulations are going to come from the WH next.