[Article 5 in a series of 6 articles. Here are links to articles 1, 2, 3, and 4.]
To support a growing economy, the Fed must create just the right amount of new money (see article 1 in this series). To create new money, the Fed must purchase Treasury bonds from the public (...assuming we’d rather not have the Fed purchasing large quantities of private assets; see article 3 in this series).
That requires a supply of T-bonds out there, available for the Fed to purchase. But where does that supply of publicly-held T-bonds come from? I thought about spelling it out in words, but decided a graphic would be better. Shown below is how several different entities combine to create that supply of T-bonds.
[Update: To see a still version of this graphic's final frame, click on the following thumbnail.]
A few things to think about:
• In the last few frames of the graphic above, what condition is the fiscal budget in? (Hint: note which direction the T-bonds are going.)
• What would happen to the public’s T-bond supply if tax receipts (A) exceeded outlays (C+D)?
• What would the Fed do if the public's supply of T-bonds disappeared?
• What would happen to the economy if the Fed couldn't create new money (E)?
Some of you may already have guessed the startling conclusion I promised when I started this series. It’s guaranteed to alienate partisan ideologues on both the left and right; that’s why it’s so much fun for me.
I’m starting to kick around some ideas for the title of that last article, but if you have any suggestions, send them to me in an email.
Isn't this fun?
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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
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