Letter to Stuart Varney, Fox Business anchor

November 9, 2008


Stuart Varney
Fox Business
1211 Avenue of the Americas
New York, NY 10036


Dear Stuart,

I heard you say on the O’Reilly Factor the other night that the Government was getting ready to borrow $900 billion over the coming months.

The selling of securities by the Treasury is often characterized as borrowing, but in reality it is simply the management of reserves in the system.

Actions taken by the Federal Reserve and Treasury over the past two months to address the credit crunch and help firms like AIG and a number of banks have caused reserves in the system to swell to $500 billion. (The average level of reserves in the system over the past 20 years has only been around $20 billion.)

In other words, the Government has already put the money in the banking system that will be used to “buy” the bills, notes and bonds that it sells over the next several months.

Remember that reserve balances at the Fed get paid a very low rate of interest (and even that has only been a recent phenomenon—reserves up until last month got paid zero interest), so it is quite normal for those reserves balances to be exchanged for higher yielding bills, notes and bonds that the government sells.

The key point—and the point that the media often misunderstands—is that the money to buy Government securities and pay taxes comes from government spending itself. The government spends first by crediting bank accounts (causing the level of reserves to rise) and then it sells securities and collects taxes, which brings down the level of reserves. If it didn’t do this we’d quickly see a hyperinflation.

The idea that the government must “raise the money” in some fashion, is rooted in gold-standard thinking. When nations were on a gold standard, the amount of gold it held determined its ability to create money. If a nation wanted to spend more it would have to get more gold.

We are no longer on a system like that. The only thing that constrains how much the Government can spend is the degree to which it creates inflation and that is a political constraint, not an operational constraint.

I hope this clarifies this for you.

Sincerely,



Mike Norman