[Third article in a series.]
In the first article of this series, we saw that a growing economy requires a growing amount of money, at just the right rate to prevent two undesirable situations: inflation (from too much money, compared to real goods and services), and deflation (from not enough). In the second article, we saw that the Fed can create money out of thin air, and the Treasury can create T-bonds out of thin air.
In this article, we’ll fill in a few details about how the Fed "creates money" (...or, to be more precise, how the Fed supports its target Fed Funds rate by responding to the public's demand for new money). The best way I can think of to fill in a few details is with a diagram:
The most common way the Fed creates money is by purchasing some of the public’s T-bonds on the open market. In other words, the Fed grabs a handful of that infinite potential supply of money, then trades that handful to the public in exchange for some of the public’s supply of T-bonds.
Simple enough, on the surface. But there are some important implications—one of which is that it requires that the public actually owns some T-bonds. Five years ago, Alan Greenspan expressed concern that the public was headed for the dubious scenario of running out of T-bonds. Here’s what he had to say about that possibility:
Continuing to run surpluses... brings to center stage the critical longer-term fiscal policy issue of whether the federal government should accumulate large quantities of private assets.
—Alan Greenspan, Jan. 25, 2001
In other words, because...
• a growing economy requires a growing money supply, and
• growing the money supply requires the Fed to purchase private assets, and
• the public’s “private assets” might someday no longer include Treasury bonds,
then...
• the Fed would have to purchase private debt or equity instruments to increase the money supply.
Reread that last bullet. The short word for that scenario is “socialism.” Connecting the dots, we can draw the following inference: When we take a step towards buying back all of the public's T-bonds (“paying off the debt”), we are taking a step towards socialism.
Something to think about next time you hear somebody advocating “paying off the debt,” isn’t it?
In any case, it now looks as if we won’t have to worry about the socialism scenario for a while. Since 2001, when Greenspan expressed his concern, we’ve increased the public’s supply of T-bonds to around $4.8 trillion. That should be plenty of T-bonds for the Fed to use for preventing both inflation and deflation, as they continue to support the private sector’s success in growing the economy. Wouldn't you agree?
======================
UPDATE: Here are links to all six articles in this series:
1 - Money:
The economy’s lubrication
2 - Two
Printing Presses: One at the Fed, One at the Treasury
3 - How the
Fed creates money without creating socialism
4 - How the
US Treasury pays back the debt
5 - The
public’s T-bond supply
6 - Paying
down the debt: Our dubious history, and a startling conclusion
======================
