Monday, February 28, 2011

Will the House of Saud collapse?

The recent escalation in oil prices (largely driven by speculators) has seemingly been muted by Saudi Arabia's promise to compensate for any loss in Libyan oil production.

However, trouble may brewing for the Saudis themselves. A "day of rage" has been planned for March 11. Wikileaks has released reports detailing the decadent behavior of the Saudi nobility.

In a land where many of the young are unemployed,this may be a recipe for revolution. For the rest of the world, it may mean the mother of all supply shocks. Contrary to the predictions of analysts like Austrian School advocate Jim 'hyperinflation is imminent' Rogers, the result could be a disastrous bout of deflation.

Index funds hold HUGE long positions in commodities!

Here is the latest data from the CFTC. All figures are in thousands of futures contracts.

As you can see, index funds are long 477,000 contracts of WTI crude. That's the equivalent of 477 million barrels. The U.S. consumes about 18.6 million barrels per day, so index funds hold about an entire month's worth of consumption. They're just sitting on it. You wonder why prices are going up?

Look at corn, it's even more unbelievable.

Index funds hold 2 billion bushels of corn! That equals about 60 million tons or nearly HALF THE CURRENT 145 MILLION TON GLOBAL STOCKS OF CORN!!

And you wonder why prices are going up?

Some central bankers express surprising candor and clarity on effects of QE

Thanks to Warren Mosler for these quotes. Got them from his blog.

Don Kohn (Former FRB Vice Chair):”I know of no model that shows a transmission from bank reserves to inflation”.

Vitor Constancio (ECB Vice President): “The level of bank reserves hardly figures in banks lending decisions; the supply of credit outstanding is determined by banks’ perceptions of risk/reward trade-offs and demand for credit”.

Charlie Bean (Deputy Governor BOE): in response to a question about the famous Milton Friedman quote “Inflation is always and everywhere a monetary phenomenon”: “Inflation is not always and everywhere a monetary base phenomenon."

Of course, don't expect these things to be picked up by the media, academic economics, Wall Street, Congress or even Bernanke. The Fed, QE, monetary and fiscal policy have all become politicized and telling the truth about QE or deficits, does no good for those who are running the show.

Sunday, February 27, 2011

Rising resource costs and the global push for austerity

Professor James Galbraith recently gave a speech about the impact of rising resource costs for economic systems. The main thrust of the speech was that with the increase in the cost of resources (oil,minerals,food,etc.) business firms face the threat of diminished profits. Galbraith presented three possible scenarios in which firms attempted to deal with this threat to profits.

The first scenario was what Galbraith called the "Chinese Model". In this scenario, Chinese firms continue to operate even though they regularly fail to make a profit. The support of the government banking system and the acquisition of a large number of long term resource contracts shields the firms from the trend of rising resource costs.

The second scenario is what I call the 'Green New Deal". Here, the approach is to adapt to a world of rising resource costs. A concerted effort to use/develop lower-cost resources (alternative energy) and increase efficiency results in the preservation of both firm profits and societal living standards.

The last case is the darkest and the one I fear is transpiring before our very eyes. Firms actively resist Schumpeter's creative destruction and instead put the onus of rising resource costs on workers. They do this by capturing/incapacitating government and dismantling the social welfare system.

Judging by the austerity wave traveling through Europe and the war on unions and government intervention in the U.S., it is evident that Western firms have chosen to declare war on workers and statism. The questions that immediately spring forth in my mind are: will they succeed and if so,what comes next?

Saturday, February 26, 2011

Why unions are on the defensive

The battle between unions and Wisconsin Gov. Scott Walker has drawn a lot of media attention lately. As is typical of contemporary mainstream media, their coverage only scratches the surface of the real story.

Progressive bloggers and independent journalists have done a far better job of cutting to the heart of the matter (see here and here). It appears that the plutocratic forces have a multi-pronged strategy: break public employee unions, deprive the Democratic party of a stalwart ally, and take over public utility assets.

However, even a substantial number of progressive and independent journalists have failed to notice a few key issues: 1) The crisis in Wisconsin and in many other states has happened because the Democratic Party allowed it to happen and 2) The absence of President Obama.

While it appears that Gov. Walker has engaged in fiscal chicanery in order to eliminate the unions and give away public assets, the larger question should be what gave Walker the leverage to do this? The Democratic Party and Barack Obama were swept into power in 2008 with dominant majorities in the House and Senate. What could have been a new, positive direction for the country quickly degenerated into a version of political Keystone Cops. Focusing on passing a Rube Goldberg health care bill and reducing the scale/composition of the fiscal stimulus under the banner of bipartisanship were costly blunders. It is exactly these mistakes that have given Walker and his masters the power to do what they are doing now.

One would think that 2 years of teabagger antics and a 2010 election shellacking would eliminate any naivete in the President. One would also think that the massive protests in Wisconsin would provide an opportunity for the President to push back against his enemies and strengthen his relationship with the middle class. Instead, we have the sound of chirping crickets.

A big pension fund manager goes to school, Mike Norman style

I had a conversation with a large pension fund manager recently on the subject of "Quantitative Easing" and deficits. This guy runs a portion of a $100 billion public worker retirement fund. (I leave him and the state, nameless.)

In the portion of money that he runs, he's heavily invested in gold because he basically thinks that the Fed is printing "too much money" and there's gonna be hyperinflation. "heavily invested," I mean that the guy has about 0.2% in gold out of that $100 bil. (I guess his bosses don't share his concerns.)

I tried to explain to this guy that there's nothing really different between a Treasury security and a reserve deposit (except for duration) and when the Fed conducts QE, all it's doing is stripping the public of one asset (a Treasury) and replacing it with another (a reserve deposit). No new money has been created and therefore, it shouldn't be inflationary let alone hyperinflationary. All that happened was that the composition of the public's financial assets changed, with a shift in duration from positive duration more toward zero duration.

He couldn't get it. Didn't wanna get it.

We didn't even go into the discussion about how there is so much slack capacity: in labor, industry, housing, etc. Where's the inflation going to come from unless it's a case of the market being manipulated (which I think it might be, but that's a whole, other story).

On the subject of gov't spending he said, "What if the Fed didn't buy Treasuries?"

The question was posed in a way that seemed to suggest that he thought the Fed was some kind of "enabler." That the Fed "funded" the government by buying Treasuries. By the way, a lot of people have this impression. I heard Schiff (gag) talk about this on Freedom Watch recently.

First let me say this: the Fed is PRECLUDED BY STATUTE from buying from the Treasury. The Fed buys bonds in the secondary market. Moreover, primary dealers, who do business directly with the Fed are OBLIGATED to participate in auctions, but granted, that does not mean they necessarily have to buy what the Treasury is selling.

But let's examine his question..what happens if the Fed went on strike and didn't buy Treasuries?

Well, as far as the government is concerned, nothing at all. The Treasury would keep right on selling bonds just the way it always does and that would drain reserves in the banking system causing the Fed funds rate to rise.

Hey, wait a minute! Cause the Fed funds rate to rise??? Well guess what? That's the same thing as the Fed having made a monetary policy move to raise interest rates, right? By not buying bonds the Fed has, de-facto, raised its target rate.

The only problem is, the Fed doesn't raiise or lower rates unless it wants to. That's why everyone waits around until 2:15pm ET on FOMC meeting see what the Fed's GONNA DO!

The FOMC decides on the rate it wants in accordance with its dual mandate of low inflation and high employment (the latter mandate may soon be taken away by Congress, at least that's how it seems from Republicans like Paul Ryan).

Why, then, would the Fed not buy bonds? That would essentially cede monetary policy directly to the Treasury and create a wonderful reason for the Fed not to exist. And unless the Fed is intent on committing institutional suicide, I don't think that happens. The Fed likes being the Fed.

Okay, what if nobody bought the bonds? I mean NOBODY! (This was actually the next question this money manager asked me.)

Then rates would probably rise to a level where risk free returns were available for below the cost of what someone could borrow money for. In other words you could go to the the bank, take out a loan for, let's say, 5% interest and invest in risk free Treasuries at, let's say, 6%? The world would be doing that all day long and soon enough that interest premium would be wiped out.

No doomsday. No end of the world, no hyperinflation.

That's how it works, Mr. Billion Dollar Money Manager. That's how it works.


We only thought trolls lived under bridges...

Ever notice the seemingly endless hordes of commenting trolls who clutter comment sections? It turns out they might not even be people per se, just a multitude of virtual personas controlled by humans. Talk about nefarious. Need support for one's particular political or economic cause (for example:a return to the gold standard) but know that you don't have a large number of supporters? Simple solution: buy an army of cyber trolls.

MSNBC anchor Cenk Uygur rips Obama on his failure to stand up for Wisconsin unions

Brutal truth, awesome commentary by MSNBC anchor Cenk Uygur!

Friday, February 25, 2011

Goldman's recent forecast regarding spending is same as my 2011 Outlook that I sent out in Jan

I sent out my 2011 yearly outlook back in January and discussed the impact of spending cuts on the economy this year. Goldman is out with theirs and it pretty much corroborates what I said over a month ago.

If you want a copy of my report, email me, it's free.

"Pro-business" Republicans elected and businesses savagely cut spending

The Republican gains in last year's midterm elections were the largest seen in 80 years. Remember, they were the pro-business party. Prior to the elections you heard all kinds of stories about how the economy wasn't doing well.

We were told that businesses were scared to make a move because they had an unfriendly White House and Congress. They warned us that the expiration of Bush tax cuts were what was keeping entrepreneurs and CEOs from making spending decisions.

These admonishments came despite the fact that from time that Obama and the Democrats took power, business investment increased by over $400 billion in real terms. All in just a year and a half!

Yet sadly, the White House and the Democrats were so inept at communicating their successes that the public ended up getting brainwashed by the the Republicans' line of tripe. They bought it hook, line and sinker.

And what did the Republicans get as a result of their successful, yet totally twisted propaganda campaign? Huge electoral gains.

The "pro-business" party was elected by a landslide in November 2010. In December we got the extension of the Bush tax cuts and other tax cuts that the Republicans said were necessary to get business investment flowing again.

So what happened? Did all this open the flood gates to massive amounts of new business investment?

No. On the investment collapsed in the fourth quarter of last year. Companies cut their spending by over $100 billion. Taht's right...they reversed more than a quarter of their investment spending that occurred over the prior 18 months in a mere three.

It didn't end there. Now the states under these remarkably economically savvy Republicans are cutting budgets in order to grow. But, ooops!...those cuts are resulting in shrinking economic activity.

Where is the president? If I were him I'd be all over this. I'd be shouting it from the rooftops! The pro-business Republcians take over and what does business do? It cuts their spending and investment. You got that...CUT!

More of this madness is yet to come as Congress gets set to unleash their own "Wisconsin" on the entire nation. With the evidence piling up all around that this austerity is a disaster, you mean to tell me that there is not one person out there capable of explaining the folly of all this? I mean, God, there's certainly enough evidence to make the case.

State spending cuts slow US economic growth in Q4

"Deeper spending cuts by state and local governments weighed down U.S. economic growth in the final three months of last year. The government's new estimate for the October-December quarter illustrates how growing state budget crises could hold back the economic recovery..."

What happened to "cut and grow?" That's the House Republican leadership's slogan.

Seems that things are not working out quite the way they planned. States "only" cut about $9 billion in spending in the fourth quarter, but cuts this year are likely to be much deeper.

The sad part about all this is that the folly of their economics, which should be so obvious to everyone right now, will probably be ignored because very powerful people want to see this happen so it's going to happen. And the president is sufficiently misguided as to aid this along. As far as the electorate is concerned, they've been propagandized so effectively that spending cuts are like religion. No one can change their beliefs about that now.

Thursday, February 24, 2011

Stock selloff starting to reflect reality of spending cuts

Look at the stock charts of General Motors and Ford, two companies that are very closely tied to personal consumption. These stocks peaked in early January when the new Congress was sworn in. GOP members of the House have been pushing deep spending cuts since then and look at what has happened to these automakers: GM has lost 15% of its value and Ford has lost 20%!

The action in these stocks suggests to me that the market is starting to appreciate--and fear--the spending cuts. This is a clear signal that overall demand in the economy could contract sharply.

Monday, February 21, 2011

Marriner S. Eccles: A man of great courage and vision during the Depression

"Without going into any detail or figures, it is recognized by everyone that our most urgent and acute problem today is to immediately provide adequate relief to the millions of our people who are destitute and unemployed in every corner of our nation. It is a national disgrace that such sufferinng should be permitted in this, the wealthiest country in the world. The present condition is not the fault of the unemployed, but that of our business, financial and political leadership. It is incomprehensible that the people of this country should very much longer stupidly continue to suffer the wastes, the bread lines, the suicides, and the despair and be forced to die, steal, or accept a miserable pittance in the form of charity which they resent, and properly resent. We shall either adopt a plan which will meet this situation under capitalism, or a plan will be adopted for us which will operate without capitalism." -Marriner S. Eccles 1933

Sad that we don't have courageous people like this today.

CNBC commentator Rick Santelli compares Wisconsin protests to 9/11!

"If the country is ever attacked as it was on 9/11, we all respond with a sense of urgency," Santelli said in a roundtable discussion on NBC's "Meet the Press" about the Wisconsin labor protests. "What’s going on on balance sheets throughout the country is the same type of attack.” -Rick Santelli

He goes on...

"This is an issue that needs to be put out into the air," Santelli said. "Many other states ultimately — they might not have the same balance sheet as Wisconsin — but collective bargaining from the federal level these are big issues, and these costs need to be put under control."

In other words, he suggests that collective bargaining--the right of workers to negotiate with employers for pay and benefits--is equivalent in some way to this nation being attacked on 9/11!

I'm starting a campaign to get this guy off the air once and for all. He's an idiot. Santelli has crossed the line on this one. Over 3000 people were murdered by terrorists on 9/11 in a premeditated attack. To compare union workers to the terrorists who commited this is disgusting. I urge everyone to contact CNBC and let them know that Santelli's comments are repulsive.

It's bad enough when he spouts his misinformed garbage on the bond market and fiscal policy, but this is too much.

Sunday, February 20, 2011

The real truth is, when it comes to the government there is no debt.

All we hear about is the debt, the mountain of debt. Debt, debt, never ends. My question is, what debt? What's the debt that everyone is talking about?

Okay, the so-called, "debt" is $14 trillion or thereabouts. That's the amount that the non-government holds in Treasuries. That's what's considered to be the debt.

So let me ask you this: what if the government had just sent out $14 trillion worth of checks to everone or better yet, $14 trillion dollar bills and just spread it around?

It would break down like this:

$9.5 trillion in checks or cash to the public, with about half of that going to foreigners like the Chinese, Japanese, Opec, etc.

$4.6 trillion in checks or cash that the government gives to agencies of the government.

In other words, the public would have gotten $9.5 trillion in checks or cash and agencies of the government would be holding $4.6 trillion of the same, checks and/or cash.

Would that be considered a debt? Would the government be considered in debt to these entities? Better yet, would these entities be considered as having a liability?

Anyone with half a brain would see that the recipients of the checks or cash would be the recipients of a windfall of new assets.

And this is exactly what has happened. The $14.1 trillion that people see as a debt of the government is really a distribution of $14.1 trillion in assets to the non-government.

And if the government sent it out as cash (Federal Reserve Notes) or checks, no one would be saying the government was in debt.

So why do we continue to hear this?

We hear it because that's the amount the non-government holds in Treasuries and people believe Treasuries to be a debt obligation, when in fact there's very little difference between a Treasury note or bond and a dollar bill. They're both accounted for the same way--as liabilities of the Federal Government--however, one has no duration (cash) and the other has some duration and pays interest.

How hard, then, is it for the government to pay that interest?

Not any harder than it is to send you a check or distribute dollar bills to you. In other words, pretty much effortless.

So why all the hysteria about the debt?

One reason: ignorance.

It's the ignorance that is killing us. The Treasuries held by the non-government is exactly the same thing as if the non-government had received checks or cash from the government, with one exception: they get paid interest. And the ability of the government to pay that interest is as easy as its ability to send you a check or some cash. There is never any problem.

So now when you hear that the Republicans or the president or Tea Party people want to "pay down the debt" you should understand that to mean they want the government to take back that check or cash that they distributed to you. That's the only way to pay it back. The government must take back those assets. And for what reason? Does it need to collect what it has already distributed and what it can freely distribute in order to function?

Think about it.

The whole thing is absurd.

Friday, February 18, 2011

Spending cuts are the fiscal equivalent of tax increases

When discussing fiscal matters it's all about revenue and spending.

Most people are against tax increases. Why? Simple, because tax increases take money away from you.

Spending cuts, on the other hand, are generally viewed in a more constructive light. Yet the funny thing is, spending cuts do exactly the same thing as tax increases: they take money away from people. So why do people love spending cuts? The same people who are opposed to taxes increases cry out for spending cuts even though both things are fiscally equivalent.

Here'a another thing that's the fiscal equivalent of a tax hike: taking away someone's benefits. When you take away someone's benefits (Social Security, Medicare, Medicaid, tuition subsidies, collective bargaining rights, annual wage increases, etc.), it's the exact same thing as levying a tax on them. It's a tax increase, pure and simple.

That's why it's so disturbing to watch the protests going on in Wisconsin and see the reaction to them. The public employees (teachers, firemen, police, etc) in Wisconsin are simply protesting against a tax increase that is about to be levied on them. This tax increase comes even as the wealthy in that state got another tax cut!

And while these protests are occurring you have this bizarre sight of private sector workers disparaging public sector workers and screaming about how they are ripping off the states and taxpayers, when in fact all workers are being hit with tax increases in thinly disguised form while the wealthy get tax cuts!

This is playing out throughout the land at both the state and Federal level. We see policies being implemented to reduce pay, benefits and services (which is the equivalent of a tax increase) while the wealthy get more money funneled their way! Even Obama's so-called tax compromise back in December did just that--it cut taxes for the wealthy while imposing a wage freeze (otherwise known as a tax hike) on Federal workers.

The really frightenting thing about this is how this whole argument is being framed in such a clever and deceptive way as to make ordinary workers look like the fat, lazy, greedy, bad guys.

This argument needs to be re-framed. People all across America need to realize that what we're seeing now on pretty much a wholesale level is that middle class workers are being taxed while the rich continue to get more and more tax breaks. All happening under a presidnet who was purportedly for the workers.

Taxation without representation!

Our forefathers started a revolution over this.

Tuesday, February 15, 2011

My not so small influence on policy :)

Last night I was talking to Democratic strategist, Bob Beckel. Beckel is an adviser to Joe Biden. (It's funny, 'cause I was sitting there and Biden called Beckel on his cell phone.)

I have been talking to Beckel for a while now about all this MMT stuff, government spending, debts, deficits, etc and have won him over to our side to the point that he's become a very good communicator of these concepts.

Well, we were discussing the president's State of the Union speech and I mentioned to him that I thought it was interesting that the president put the issue of the deficit way back near the end of the speech almost as if to de-emphasize it. Then Beckel said to me, "Mike you don't realize how much of an influence you had on that."

I was shocked.

He told me that he had been explaining all this stuff to Biden and Biden was a key player in the White House in terms of framing the State of the Union speech. He said Biden argued strongly for de-emphasizing the deficit, while another group of fiscal hawks at the WH wanted to make it a priority. The hawks lost the debate and according to Beckel, that was due in no small way to me!

Chances of a government shutdown rising

I was talking to Democratic strategist Bob Beckel at Fox yesterday on the subject of the president's budget and likelihood of a government shutdown. Until recently Beckel had been pretty sanguine about the latter, feeling that is was all bluster by the Republicans and nothing more. Yesterday, however, he indicated to me that it now looks pretty certain--CERTAIN--that the Republicans would force a shutdown.

I do not know what directional impact this will have on the markets, but I do know this: a shutdown and the discourse leading up to such an eventuality will create a lot of volatility.

Sunday, February 13, 2011

All money emanates from gov't spending...ALL MONEY!

Try this one on a friend or colleague next time you get into some kind of money discussion.

All money emanates from gov't spending...ALL MONEY!

I mean, where do you think money comes from, anyway? Do you print it up in your basement? Does your neighbor print his up?

When you pay cash, where did those bills come from?

Even bank money--i.e. credit--comes from gov't money.

Yes, when a bank makes a loan it is merely an accounting entry, so the bank did create its own money out of thin air. And the bank's credit is usually good for the purchase of goods and services.

However, bank money can only be issued with the simultaneous creation of RESERVES and only the government (via the Fed) can create those reserves. Without reserves, no credit under the current structure.

And like I said, bank money can pay for most things, but it can't pay your taxes. Only reserves--the government's own money--can settle your bill with the IRS.

All money comes from government spending...ALL MONEY!

Wednesday, February 9, 2011

House Republicans hand down their first wave of cuts, many programs hit

Here's the first wave of House GOP cuts, a total of $43 bln. Some of these programs that are being cut are great programs that have helped many and contributed to a cleaner environment.

Cuts to:

Environmental Protection Agency, Corporation for Public Broadcasting, family planning assistance, Pell Grants and other education grants and programs and possibly furloughs of federal workers.

A stripping away of services and income by a gang of blind ideologues, in the name of their "religion," which is fiscal conservatism. Blame a totally misguided and propagandized public who threw their support behind these fanatics.

No we can all look forward to a return of Love Canal, tumbling educational levels and more unopposed, poisonous right wing media.

Bernanke is part of the problem

An exchange between Bernanke and House Budget Committee Chair, Paul Ryan (R-WI). It shows how Bernanke has become part of the problem.

Ryan: “Just to summarize, you do believe that one of the best things we can do for short-term economic growth is to put out a plan that actually stabilizes our fiscal picture, that actually gets our liabilities under control, and shows, with confidence, that we have the right trajectory because we’ve addressed the programs — which are spending programs — that are getting us out of control. Is that the case?”

Bernanke: “That’s correct.”

Friday, February 4, 2011

House Majority Leader, Eric Cantor, in our office on Monday

Eric Cantor, the House Majority Leader, will be in the offices of John Thomas Financial on Monday. I will ask him about the debt ceiling and spending cuts.

Thursday, February 3, 2011

YTD Fiscal Snapshot

Following is some data in regards to the posture of fiscal policy FYTD, through the end of January, 4 months into the FY, and a YoY comparison. (data from the US Treasury's DTS)

FY 2010 as of Jan 30:

Total Treasury Account Withdrawals: 3678
Minus Treasury Redemptions: 2314
Equals Net Treasury Withdrawals: 1364

Total Treasury Account Deposits: 3494
Minus Treasuries Issued: 2514
Equals Net Treasury Account Deposits: 980

FY 2010 YTD (Jan 30) Deficit: 384B

FY 2011 as of Jan 30:

Total Treasury Account Withdrawals: 3707
Minus Treasury Redemptions: 2357
Equals Net Treasury Account Withdrawals: 1350

Total Treasury Account Deposits: 3746
Minus Treasuries Issued: 2808
Equals Net Treasury Account Deposits: 938

FY 2011 YTD (Jan 30) Deficit: 412B

So you can see from this data that it looks like YoY ‘Tax receipts’ or net Treasury account deposits are down from 980B to 938B. The fiscal deficit has increased by 412-384=28B, or approximately $100 per capita, $25 per month per capita. Net Withdrawals have decreased by 1350-1364=-$14B or -$40 per capita, -$10 per month per capita. This means that now YoY, the government is "spending less", that is, the government has had less 'real' withdrawals from it's account at the Fed at this point in the fiscal year versus last fiscal year.

On the non-govt side, Bank credit (via the Fed's H.8) is flat to down (it is probably down 100's of $B) YoY if you factor in the $300B+ add to Total Loans & Leases in Bank Credit due to CIT Financial bankruptcy on-balance sheet adjustment last April. Crude is up, net imports are up.

This is not a lot of support for the economy or growth; and the worse news is that the government policymakers believe that they are spending too much.

Throughout this fiscal year the country has been operating on a "continuing resolution" instead of actually passing a FY 2011 budget. The CR seeks to mimic the discretionary spending levels of the previous year so perhaps it should not be surprising that these YoY comparisons do not indicate much change in expenditures. This could change going forward if a budget is passed, with perhaps some YoY increase in expenditure rates, but the new Congress keeps insisting on YoY discretionary spending CUTS so this seems less likely.

Wednesday, February 2, 2011

MMT for a "Tall Blonde

This is a re-posting of a comment by Tom Hickey, that explains the MMT very well I think (Probably not good for dinner conversation but good for a blog ;)

Tom Hickey Reply:

April 3rd, 2010 at 12:38 am

The key here is the MMT concept of vertical and horizontal in relation to money creation. This is sometimes called exogenous (outside) and endogenous (inside).

When the government “spends,” the Treasury disburses the funds by crediting bank accounts. Settlement involves transferring reserves from the Treasury’s account at the Fed to the recipient’s bank. The resulting increase in the recipient’s deposit account has no corresponding liability in the banking system. This creation is called “vertical,” or exogenous to the banking system. Since there is no corresponding liability in the banking system, this results in an increase of nongovernment net financial assets.

When banks create money by extending credit (loans create deposits), this occurs completely within the banking system and results in a liability for the bank (the deposit) and a corresponding asset (the loan). The customer has an asset (the deposit) and a corresponding liability (the loan). This nets to zero.

Thus vertical money created by the government affects net financial assets and horizontal money created by banks does not, although its use in the economy as productive capital can increase real assets.

The mistake that is usually made is comparing what happens in the horizontal system with what happens at the level of government accounting. At the horizontal level, debt is the basis for horizontal money creation. Therefore, it is often assumed that debt must be the basis for the creation of money by government currency issuance. This is not the case.

Reserve accounting uses the standard accounting identities, but the meaning of “liability” is not “debt.” The husband-wife analogy for CB-Treasury accounting relationships is apt. Since a husband and wife are responsible for each others debts, neither can be indebted to the other. That is to say, reserve accounting is a fiction that does not represent real relationships, such as exist between a creditor and debtor in the horizontal system.

Moreover, government debt is not true debt either. At the macro level, the reserves that are transferred to banks through government disbursement are used to buy Tsy’s. That is, when a Tsy is bought, this involves a transfer of reserves from the buyer’s bank’s reserve account at the Fed to the government’s account (consolidating CB and Treasury as “government”).

When the Tsy’s are sold or redeemed, the reserves that were “stored” at interest are simply switched back, creating a deposit again. It’s pretty much the same as buying and redeeming a CD. It’s just a switch from demand to time back to demand in a bank account, and a switch between reserves and securities at the government level. That is to say, the government doesn’t have to draw on revenue, borrow, or sell assets to cover its “debt,” as households and firms do. It’s just a matter of crediting and debiting accounts on the (consolidated) government books, even though it may appear that there is a financial relationship occurring between the CB and Treasury due to the accounting. However, it’s just a fiction.

Therefore, the key to understanding MMT is this vertical-horizontal relationship. When one understands this, then Abba Lerner’s principles of functional finance become obvious. (1) Currency issuance through government disbursement is used to increase nongovernment net financial assets, and taxation withdraws net financial assets from nongovernment. (2) Debt issuance by the Treasury is a monetary operation for draining reserves to permit the CB to hit its target rate.

These principles are then applied to Y+C+I+G+NX to balance nominal aggregate demand with real output capacity in order to achieve full capacity utilization, hence, full employment, along with price stability. This is based not on theory requiring assumptions but on operational reality that can be represented using data, standard accounting identities, and stock-flow consistent macro models.

All of this and much more is explained in considerable detail at Bill Mitchell’s blog.