Friday, May 1, 2009
Don't fear hyperinflation: Treasury sales are a powerful countervailing force
One of the most fascinating things to look at from an economic standpoint is the Daily Treasury Statement, which is available on the Treasury’s website (http://www.fms.treas.gov/dts/index.html).
It is an itemized list of all the daily payments and receipts of the federal government. If you want to know exactly how much the government spent on defense yesterday, that figure is there. So, too, are the payments for agriculture programs, NASA, interest on the debt, Social Security and everything else the government spends money on.
By the same token if you want to see just how much the government collected in taxes or from those pesky air transport security fees that you have to pay every time you buy a plane ticket, you’ll find those too.
When looking at the statement one is instantly struck by the fact that the government is spending and collecting money every day and usually it is spending more than it is collecting. This means that there is a net increase in money, in the form of reserves, flowing into the banking system. (Remember, these are just credits that occur from a keystroke on a computer.) Therefore, when the government spends in excess of what it takes in it is acting like a giant “money pump” pushing money into the economy.
So if the government is pumping money into the economy on an almost constant basis isn’t this inflationary? The answer is, it can be, if it is done without control.
That's where the story gets even more interesting.
In addition to all the daily payments and receipts on the statement you will also find the total sales and redemptions of government securities. Remember, when the government sells securities bank reserves go down and when it redeems securities, bank reserves increase.
Looking at the numbers one finds that in the current fiscal-year-to-date the government has sold $5.1 trillion of Treasury securities and it has redeemed $4.07 trillion. What this means is that the government has drained reserves by a net amount of over $1 trillion! At the current pace the government is on track to eliminate not only ALL reserves in the banking system, but the entire monetary base (reserves, bills and coins) as well! In other words, if left unchecked the government’s actions would cause the very foundation from which all money emanates to completely disappear! Another way to say this is that there would be no more money!
So you can see that by no stretch of the imagination is that inflationary. On the contrary, it carries the potential for a financial collapse of unprecedented proportions. But don’t worry because it’s not going to happen.
The reason it’s not going to happen is because there is a counterbalance to all this and that counterbalance is the Fed. Because the Fed sets interest rates it is OBLIGATED to provide whatever reserves necessary to sustain its interest rate. And since the Fed funds rate is now set at zero the Fed will have to continue to supply enough reserves to offset the drain caused by the sale of Treasuries.
Many people have said that it is going to be “very hard” for the Fed to contain inflation because it has fostered such a big increase in the monetary base (mostly reserves). But when you understand that the Treasury’s ongoing public debt sales constitute such an enormous drain on reserves you see that, in actuality, the Fed has to do very little to keep inflation in check because the Treasury’s doing all the work. In fact, the only thing the Fed really has to do is simply let its various lending programs expire. That alone would cause reserve balances to fall and the threat of inflation recedes.
Falling reserve balances would put upward pressure on interest rates, but the Fed could counteract that by maintaining the desired reserve level. However, once the Fed feels confident that the economy is on the mend it will surely adjust its interest rate higher and allow reserve balances to come down to the level so that its new target rate is sustained.
So you see, it’s not all doom and gloom. It’s really quite logical and like anything else, once you understand how it works it takes all the mystery and fear out of it. It’s just sad that the folks at Treasury and at the Fed don’t have some better P.R.