Subject: A Primer on Money Date: Mon, 01 Mar 1999 18:28:36 GMT From: wfhummel@mediaone.net (William F. Hummel) Organization: MediaOne Express, Western Region Newsgroups: sci.econ 1. Government spending does not increase the money supply. All spending is financed with funds recycled from the public via taxes and/or bond sales. In extremis the government could "print" money to cover its spending, but that has not happened since World War II. 2. The Treasury does not accumulate money balances in excess of its near term obligations. Thus the circular flow of funds between the Treasury and the public is essentially balanced at all times, regardless of whether the budget is balanced or not. 3. The banking system, including the Federal Reserve, is the source of all the money in circulation. The Fed issues definitive money, comprising deposits at the Fed plus currency and coins. Banks issue credit money which is the largest component of the money supply. 4. The Fed influences the amount of bank lending through its control of the inter-bank lending rate, i.e. the short term interest rate. It does not directly control the amount of credit money created by the commercial banks, which are private profit-seeking enterprises. 5. The amount of money in circulation is a function of demand for bank credit at the going lending rates. Banks will normally lend to credit-worthy borrowers willing to accept the obligation of interest payments and return of principal on a date-certain. 6. Bank lending is limited by the capital ratio requirement set by the Fed. The reserve ratio requirement functions only to create a market in inter-bank lending whose interest rate the Fed can control, i.e. the Fed funds rate. 7. The national debt owed to the public can be maintained indefinitely by simply rolling over maturing T-bonds. Paying off the debt would not create money that could be used for other purposes by either the public or the government. Every dollar of debt paid off would simply transfer tax payer dollars to bond owners. The end result would simply dissolve the credits the public uses as a savings vehicle. William F. Hummel http://people.we.mediaone.net/wfhummel REPLIES: Willaim F. Hummel wrote: >>7. The national debt owed to the public can be maintained >indefinitely by simply rolling over maturing T-bonds. Paying off >the debt would not create money that could be used for other >purposes by either the public or the government. Every dollar of >debt paid off would simply transfer tax payer dollars to bond >owners. The end result would simply dissolve the credits the >public uses as a savings vehicle.>> gchand4059@aol.com: I am having trouble with this. 15% of U.S. outlays are for "Net interest on the Debt" (Ref. pie chart in the 1998 Tax 1040 Forms and Instructions, next to index.) If there was no interest to pay this 15% could be spent on something else. Also, to what level is your primer addressed? For example, would it be good for our congressmen? For a high school student? For a freshman economics student? Minimum knowledge for anyone who wants to understand the national debt? William F. Hummel: Suppose the debt could be paid off with a tax surcharge for some period of time, while the remaining items in the budget stayed in balance. All of the tax revenues from that surcharge would go to the bond holders. When the debt was paid off, the government would no longer have to pay that 15% interest. But where is the 15% the you think could be spent on something else? It doesn't exist. The government finances its spending, including paying interest on the debt, by taxes and/or borrowing. That reciprocal flow between the government and the public is essentially balanced regardless of the size of the debt. The government does not accumulate recycled funds in excess of its near term obligations. >Also, to what level is your primer addressed? .... It's to hopefully clear up some basic misconceptions that keep showing up on sci.econ. You be the judge of what level. AND: "Michael L. Coburn" I want to make it very clear that I am not saying that what has been described heretofore in regard to how the system works is incorrect. The statements from Mr. Hummel are not incorrect in this perspective. I wish to address how IMHO the system _should_ work by asking questions and formulating considered mechanisms to address the shortcomings of the current system. To say that it makes no difference whether government spending is financed through borrowing or taxation may actually be correct in that most disagreement about such a statement is based on the effects on given segments of the society/economy as opposed to looking at the entire tax base as one big clump. If we look at the society as one big clump and we look at taxes as being evenly applied and government services being evenly applied then it may not make any difference how such government services are funded. But from a personal or professional standpoint (assuming you profession isn't economics), the results of taxing verses borrowing depend upon what is taxed, and who is taxed, and who is the beneficiary of government services, as compared to who receives interest from government borrowing and who gets the benefit of services provided by such borrowing. Left undiscussed here are the effects of simply creating the money needed to finance government operations over and above those which can be underwritten by taxation. In effect a loan with NO interest. IMHO we would very quickly see a balanced budget as all the rich people screech about their money getting watered down and refuse to support any candidate for office who would commit such heresy. William F. Hummel: Fair enough. When interest on the debt becomes a sizable fraction of the government budget, the redistributional effects can be important, and potentially unfair to a subset of the public. I don't think we are anywhere near that situation now. In FY1997, government spending was as follows, copied from: http://www.fms.treas.gov/pdf/citizen.html Social Security 22.8% Other expenses** 18.8 National defense 16.9 Interest on the debt 15.2 Medicare 11.9 Unemployment, disability, & 8.4 other income security payments Medicaid 6.0 **Other expense were not defined but are probably a wide variety of discretionary spending programs. I previously posted a breakdown of who owns the debt, i.e. where the interest payments are going. From that it appeared the benefits were rather widely dispersed and not heavily favoring any particular class (ignoring the foreign-owned component). Interest payments would have to be heavily skewed toward the high income group to compensate for the much higher tax burden they carry. I have not seen any real evidence of such skewing. >Left undiscussed here are the effects of simply creating the money needed to finance >government operations over and above those which can be underwritten by taxation. >In effect a loan with NO interest. IMHO we would very quickly see a balanced budget >as all the rich people screech about their money getting watered down and refuse to >support any candidate for office who would commit such heresy. I see nothing to commend this proposal. You are not distinguishing between real assets and money when you refer the rich people. Bill Gates is a multidecabillionaire in real assets, not in money. "Watering" the money supply would selectively hurt those whose assets are liquid, not those whose assets are mostly in vast properties. In any case, there would be all sorts of collateral damage, and I doubt that rich have that much voice on who sits in Congress. Remember Newt? AND: William F. Hummel: >>1. Government spending does not increase the money supply. All >>spending is financed with funds recycled from the public via >>taxes and/or bond sales. In extremis the government could >>"print" money to cover its spending, but that has not happened >>since World War II. (Chasna1) wrote: >This comment needs to be qualified. I think it's correct to say directly the >government hasn't printed money lately, but that some portion of new Treasury >debt is currently , in fact, indirectly monetized would be an even more >correct statement. William F. Hummel: I have no idea what the expression "indirectly monetized" means. The Fed monetizes Treasury debt precisely for the purpose of creating additional banking system reserves. It does so by purchasing Treasury securities directly from the public. To date, the Fed has monetized about $450 billion of Treasury debt. It rolls those Treasury securities continuously and buys more as required to meet the demand for an increasing money supply. A small fraction of the interest earned on those securities goes to pay for its operating expenses and the remainder (about 90%) is returned to the Treasury. The Fed has also monetized the entire Treasury gold stock, and holds the certificates of ownership. In doing so the Fed credited the Treasury's account by the value of the gold stock, a total of about $11 billion at the statutory price of $42.22 per ounce. For further details on monetizing the gold stock visit http://people.we.mediaone.net/wfhummel/goldstock.html William F. Hummel