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 (

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.


Matt Franko said...

When I look at the DTS for April 30,2009, I look at the Withdrawl (right) side of the statement as sort of Govt spending. As you say I can see the NASA/DOD/Medicare etc withdrawls (ie spending), then they show Treasury Security redemption (not really spending to me). Where Im getting a bit sideways is at the bottom of Table 2 with these items that are called "Transfers". They have "Transfers to Depositaries" for 225,223M FROM the Federal Reserve Account; and "Transfers to Federal Reserve Account" FROM Tax and Loan Note Account of 1,122,890M. I guess I am having trouble understanding where these funds came from and to whom they are going. They may be just intra-Govt tranfers of funds, but I am trying to figure out if they affect reserve balances, etc.

Our leaders do not inspire confidence with some of the statements they make (as you have often pointed out (Walker/Jud Gregg etc...), and I (half) believe they could engineer the "potential for a financial collapse of unprecedented proportions" you point out above.

Resp, Matt

mike norman said...


Transfers from depositaries (banks) to the Treasury's account at the Fed. That's any payment from the public to the U.S. Treasury. Transfers to TTL accounts are accounts of the Treasury held at commercial banks used for the collection of taxes.

mike norman said...

Any transfer from the public to the Treasury's account at the Fed reduces reserve balances. Transfers from the Treasury's acct at the Fed to depositaries increases reserves.

Transfers from TTL accounts to the TReasury do not reduce reserves as they have already been debited.

Treasury transfers of TTL account balances to the Fed also do not increase reserves.

Matt Franko said...

Thanks again for your insights.

So what I take from your statements is:
Xfers from depositaries: Drain
Xfers to Depositaries: Increase
(in reserves)
So if I again look at the DTS Table 2 for 30 April 09, there are 2 line items that are called just that.
On Withdrawl side there is ytd "Transfers to Depositaries: $225B"
and on the Deposit Side "Transfers from Depositaries: $1.123T". So if this is how it nets out, that is a reserve drain of $898B. So is it fair to say that so far in FY 09, Treasury Operations have resulted in a reserve drain of $898B? Wouldn't this be SEVERELY damaging for the economy by itself?

Resp, Matt

STF said...


Your logic about reserve adds/drains is correct. I haven't checked the numbers myself, but remember that the qty of reserves is COMPLETELY IRRELEVANT. Treasury bond sales are an asset swap, replacing an overnight account on the Fed's books (reserves) with a time deposit on the Fed's books (Treasury security, the records for which are kept on the Fed's book entry system) . . . it's the size of the deficit that matters. Whether you sell a bond or not, the contribution to net financial assets of the private sector is the same with a given deficit.