Cullen, after looking at some of your stuff I think I have moved in your direction from MMT.
Deficit Spending and National Debt
When private banks create loans out of thin air (they don’t really do fractional reserve banking anymore, because with fiat money you don’t need to lend gold-based money of depositors to borrowers and then borrower has to find gold-based money to pay it back), they add new money into circulation through the borrowers. But when private banks want to buy securities from the Treasury who may issue it for deficit spending purposes, the private banks have to get reserve settlement dollars to buy them. I think they do this through correspondent banks who exchange their bank created dollars for reserve (settlement) dollars. Banks then can buy the securities from Treasury. The Treasury takes the reserve dollars and these are deposited in the Treasury’s account at the Federal Reserve. The Treasury then can direct the Fed to deposit the reserve dollars into reserve accounts at private banks who have depository accounts of individuals and businesses whom the federal government wishes to pay or grant money to. If the private banks don’t have enough bank-created dollars on hand, the private banks then go to their correspondent banks and exchange the reserve dollars for bank-created dollars and take these dollars and deposit them in the accounts of the individuals and businesses that the Treasury directs be paid. The reserve settlement dollars never go into circulation along with private bank dollars. They remain in the aggregate federal banking system in constant quantity and are recycled over and over with the help of correspondent banks’ lending their reserve dollars to one another.
On the other hand the private banks’ dollars–converted in the interrim into reserve settlement dollars–get back into the economy when the bank created dollars are spent into circulation by the private bank depositors who received the money from the government. Those dollars ultimately are new money and do add to the quantity of money generally and in circulation with the potential to create inflation under the appropriate circumstances.
When the securities mature, the banks have the option of selling the mature securities at public auction or rolling over the securities with the Treasury swapping new securities for the mature securities plus interest that it can get by also borrowing from banks.
At the auction the Fed can and likely will buy the mature securities with money created out of thin air. But since this cancels the banks’ loans to the Treasury via the securities sold to the banks, the Fed’s dollars are extinguished in the same manner that payback of loans by private borrowers extinguishes the money lent to them by private banks. The Fed can also buy those securities from banks in Quantitative Easing by directing the banks to sell them to the Fed. Again the Fed’s reserve dollars go into banks’ reserve accounts but are extinguished as before, while the Fed gets the securities. The Fed is not creating dollars that cause inflation. Banks will exchange these reserve dollars for bank-created dollars at their banks’ correspondent banks, and these will then be extinguished as the loan to Treasury is closed out. In the meantime the Fed will hold on to the Treasury securities until inflation arises. At that point they will go to the Treasury with them and swap the mature securities for new securities, which the Fed will then sell to banks and private investors to drain money out of circulation to fight inflation.
The Treasury having the securities back from the Fed will extinguish them and the debt created by them also is extinguished.
But the new securities swapped with the Fed do represent new debt, which the Fed assumes when it sells them to private and foreign parties. But since these securities do not back deficit spending but fight inflation the dollars remain in reserve securities accounts at the Fed, which the Fed will return to the securities holders at maturity plus interest which Fed can create out of thin air.
Private and foreign investors can also buy Treasury securities to earn interest and have a safe place to keep their dollars. Although these add to the national debt, they are like bank debt on time deposits in the form of CD’s. The money is always there in the bank to be returned, which is no problem for the bank (or by the same token, the Fed— or the taxpayers who have nothing to do with this).
This view holds that private banks create dollars out of thin air in purchasing securities from Treasury–not the Fed. But Fed can buy back the securities with dollars created out of thin air and effectively cancel loans by banks to the Treasury to buy securities. It may do this at ppublic auction and with Quantitative Easing.
It also takes a position involving correspondent banks in the process of getting reserve dollars with which to buy the securities. The Fed is not directly involved in creating the money for buying the securities.
Another position I have developed concerns a differential equation borrowed from hydrology. It concerns inputs to and outputs from circulation where dollars are actively involved in transactions involving exchange of goods and services for dollars. The equation concerns the change ΔC in quantitity of money in circulation as a function of the total input minus the total output of money into circulation.
ΔC = [X + G + I + L] – [M + T + S + P] where
X = inflows of export dollars,
G = government spending, i.e. G = V + D where V are dollars from taxes and D deficit spending dollars.
I = investment by business
L = loan dollars created by banks out of thin air and spent by borrowers into circulation.
M = dollars leaving circulation in United States in purchase of imports.
T = taxes collected by government, T – V > 0 means a surplus
S = savings (securities, savings accounts in banks, unspent dollars held by private individuals for a long time.
P = payback of bank loans by borrowers from banks.
The equation indicates that banks create new money entered into circulation so government is not only creator of dollars. When borrowers pay back their loans, these dollars leave circulation as the dollars are extinguished (perhaps shifted into vault cash or bank dollars on hand).
The equation also considers the many possible combinations of different inputs and output mixes that could yield the same resultant ΔC.
This equation suggests that the goal is not fiscal balance of government spending versus tax revenues and a balanced budget. Rather it suggests that there is a desired level C’ of dollars C in circulation that are to be attained by appropriate modulation of ΔC. When an economy is growing the government should seek to encourage growth by seeking ways to increase dollars in circulation C to higher and higher levels by seeking ΔC > 0. C’ will be defined as the level of dollars in circulation at full production and full employment with stable prices.
Once the level C’ is attained, adjustments should be made to keep at that level by making inputs and outputs equal so that ΔC = 0. Allowing more dollars to enter circulation after C’ is attained, means ΔC is still greater than zero and is now excess. The dollars cannot increase production nor create more employable workers and will only lead to rises in prices as those with excess dollars bid up the prices they are willing to pay for the level of goods and services produced at full production. In other words, when excess dollars enter circulation after reaching level C’, the excess dollars create inflation. On the other hand, if the level of C < C’, fewer goods are produced and sold, workers have to be laid off as businesses see not enough dollars to clear the market at the original prices. Prices are lowered. Fewer employed workers means fewer consumers, so there will be a downward spiral of production, prices and employed workers until production is just producing enough for the current employed consumers to be just able to buy the goods produced at that level. Meanwhile unemployment has occurred and the economy is either in depression or a recession. In that case the proper remedy is for government to encourage imports, curtail imports, lower taxes and increase government spending with deficit spending.
The level C’ at full production and employment will not be a stable point. Monitoring this level by monitoring employment, production, and prices to detect either inflation or deflation will be essential. This level will change with increases or decreases in population, increases or decreases in availability of resources and raw materials needed for production, changes in productivity from technological advance or decline. There is no assumption of an inherent equilibrium. So countercyclic processes need to be developed to adjust actively the maintenance of a level of money in circulation needed to clear the market at full production and employment at stable prices and wages,
The model behind this equation also requires a government to focus on seeking efforts and procedures to adjust the various inputs and outputs of money in circulation to maintain a stable level at C’. Depending on conditions in domestic and foreign exchange and/or government spending heavily on defense and health care, will require offsetting adjustments needed to prevent inflation by increasing certain outflows to savings, imports, or taxes. Sales by Treasury or Fed of securities may be used to drain money out of circulation into time deposit accounts.