The "profit" I referred to was specifically for the printing of cash. And who exactly is in debt when that happens? The bank got legal tender worth exactly the amount it exchanged for it. The Treasury had it's printing costs covered. The Federal Reserve made a small profit on the transaction. This difference in money doesn't just disappear, it gets used to cover the operating expenses of the Federal Reserve Bank, it is used to buy and sell securities, etc, it ends up out in the economy.

I'm not sure where your idea that profit = interest comes from, do you feel like you are in debt to the local grocery store whenever you buy food for more than it cost them to get it? Maybe we're using a different definition here and it's simply a semantic difference we have here, but I don't see who is in debt to who in the case of printing cash (which is a small part of the situation anyway). Cash is essentially interest free money from the government. But you have to be careful about how much of that you issue or you end up with huge amounts of inflation.

As to the dollar losing 95% of it's value, that's a natural consequence of the economy expanding. You have to have some inflation in order for the economy as a whole to grow, and it's nearly impossible, under any monetary policy, to perfectly control inflation. You are aware that under the Gold Standard, the value of the dollar went through many wild fluctuations. Sometimes as a result of new gold being discovered (value went down), and at other times as a result of there not being enough of it to cover the economic expansion occurring (value goes up). Inflation as a whole is not necessarily bad, as long as wages keep pace.

I absolutely agree with you on the problems of the rich getting richer, and the poor getting poorer, but I'm not sure I think the blame for that can be laid at the feet of the Federal Reserve or more basically the monetary system of the United States. The problems it seems to be stem more from poor stewardship of the economy by congress and the presidents. Monetary policy, which the Fed is at least partly in charge of, is only one part of the economy, and can only effect things so much. Spending by congress, laws regulating industries, education, infrastructure, tax policy, all of these things are much more likely to effect the wage gap, and the loss of real wages by middle and lower class Americans, and none of them are under the control of the Federal Reserve.

Finally, you can certainly criticize the Federal Reserve for not doing a good enough job at it's primary purposes, controlling inflation and keeping employment steady, but the blame for that likely lies more with the people who have been in charge than necessarily with the system as a whole. Further, returning to the gold standard, or some other monetary system wouldn't necessarily magically fix these problems. Regulating an economy as big as that of the United States (especially now, with all of the ties around the world), is a very, very, difficult job. I for one, like the idea that the Federal Reserve, as a quasi-private entity, that is self funding, with governing board appointments that rotate and last long enough to not let any one president or congress "pack the board," is in charge of some of these aspects of the economy, so it's at least somewhat insulated from politics (but ultimately always accountable to congress).

Sorry, didn't see your last post as I was writing my last one.

The Federal Reserve is not the problem when it comes to "borrowing from the future." Congress is. If Congress stopped over spending, the Treasury could drastically reduce the amount of bonds it issues, because there would be no need to borrow to cover the difference in spending and income. The Treasury could start retiring debt (which would in itself inject more money into the system), and the Federal Reserve could use something else as collateral, it would simply have to find something of stable value that it can easily and quickly buy and sell. This could be gold or other precious metals! There is nothing that prevents the Fed from using other assets, but Treasury Bonds are trusted, stable, and readily bought and sold, to control the money supply.

I'm just going to copy+paste a few things that are filed under some common misconceptions at http://www.wfhummel.net/misconceptions.html

The government causes inflation when it prints too much money.

Money is literally printed by the government only to meet the demand for portable currency, i.e. Federal Reserve notes. The notes are issued to banks in exchange for deposits the banks hold at the Fed. The public acquires the notes in exchange for their own deposits at banks. The amount of currency issued is no more and no less than the public desires to hold as wallet money or rainy day money. It has no bearing on inflation.


Price inflation is mainly caused by too much money chasing too few goods.

This reflects a misunderstanding about how the money supply grows in a modern money system. Money exists mainly in the form of bank deposits, created when banks issue loans. Money growth thus depends on the demand for bank loans and the willingness of banks to lend. The Fed can influence the demand through its control of the interest rate, but it does not directly control the amount of bank lending. If the Fed sets the interest rate too low for an extended period, the amount of bank money could grow enough to put upward pressure on prices. That mainly affects asset prices, but is seldom the cause of consumer price inflation.


The Fed controls the size of the money supply.

A bank in the U.S. must hold reserves of base money in proportion to the amount of its demand deposit liabilities. However the amount a bank may lend is limited by its own capital, not its reserves. In order to maintain control of the Fed funds rate, i.e. interbank lending rate, the Fed must provide whatever reserves are required by the banking system as a whole. In fact if the Fed withheld reserves, it could imperil the liquidity of one or more banks. Thus for all practical purposes, the Fed cannot even control the amount of base money it issues.

I'll point out again, The Federal Reserve isn't the source of the debt you're so concerned about. That's the Treasury. (Or maybe banks through fractional reserve banking, but that's been going on for thousands of years, and seems to be relatively stable, and allows people to put money into banks (effectively loaning them money) and earn interest on their accounts. If you forced banks to hold 100% reserves, they couldn't loan money, and people would actually have to pay banks to hold their money (to cover administrative costs and such). The system of debt that we have for money creation (Fractional Reserve Banking), is a reasonable way to let the market have some say in how much money it needs at a given time, and has a number of benefits over other systems. It also has some pitfalls, but I think they're worth it personally.

DrOct...maybe it is semantics we are arguing...or maybe I'm just a dullard and cannot understand money (no comment from you Withnail! :)

Cuz I thought we established that by virtue of the FRA, the Fed is a perpetual debt monetary system.

And I thought that we also established that the Fed charging interest on the creation of money is the root cause of perpetual debt.

Are either of those two statements false?

"I'm not sure I think the blame for that can be laid at the feet of the Federal Reserve or more basically the monetary system of the United States."

But didn't the Federal Reserve Act, which gave birth to the Federal Reserve, establish the monetary system (not policy) of the United States?

"but the blame for that likely lies more with the people who have been in charge than necessarily with the system as a whole."

That's true to a degree...but how far is the disconnect from people who have been in charge and the system itself?

"Further, returning to the gold standard, or some other monetary system wouldn't necessarily magically fix these problems."

I agree...I wasn't suggesting that it would fix them magically, but that it would make it better in the long run. But perhaps that's not true either.

"Regulating an economy as big as that of the United States (especially now, with all of the ties around the world), is a very, very, difficult job."

Agreed.

"I for one, like the idea that the Federal Reserve"

In it's present form, I strongly disagree...here's my response from above: "I just don't see how never being able to pay your debts to your creditor is good. Does that not leave your creditor in a position of power having to always be indebted to them? And if the Fed represents perpetual debt, is not the Fed (along with it's private banks) in a position of power?"...after all, they control inflation and deflation.

Guys, I do appreciate the input here...thanks!

I think you're missing something about the way the Fed works, but I don't have the time to do the research right now. The Fed is the one who puts the US in debt by issuing bonds to other countries. Or is that the Treasury?

Either way, the only rate they really control is the interbank rate which is very short term.

I do remember from Economics that a good Fed's primary goal should be to control inflation. When the Fed starts making moves to "stimulate the economy" we're all in trouble.

I actually think that the first two statements are in fact both not correct, which I've been trying to point out is probably the root cause of the problems here.

When the Federal Reserve prints cash, it charges no one interest. It is exchanged to a bank at face value. Once the bank has traded some of it's assets for the physical bills, it has no further obligation to the Federal Reserve, it has gotten money that is worth exactly what it traded. No one is in debt to anyone else.

When the Federal Reserve creates money by buying securities (generally Treasury Bonds), it is injecting some money into the system, which eventually ends up in banks as a deposit, which then allows them to loan more, and thus creates more money. The only debt involved in this transaction is the debt the Treasury owes whoever holds that bond when it matures. If the Federal Reserve is still holding it when it matures, it uses some of the money to cover it's operating costs, and to cover the reserves of the member banks (so that should they need them they will be available), and the small interest paid to the Banks on the holdings they are forced to have on deposit with the Federal Reserve. The rest of the Federal Reserves profits go back to the treasury. This usually works out to about 95%, and is basically cost neutral with the amount of money the Treasury would have to spend to manage money creation itself.

I'd also point out, again, that the Federal Reserve, when it was first created, operated, until 1933, in a US economy that was in fact based on the Gold Standard. From 1933 to about 1971 it operated in a system that was sort of a quasi-gold standard, and finally in 1973, the gold standard was officially retired. There is nothing inherent in central banking that has to do with debt being the source of value for money.

@mckayje3 - To your first statement, it is in fact the Treasury that creates and sells the Bonds in the first place. The Federal Reserve buys and sells them (on the open market, they are prohibited from buying directly from the treasury), in the course of trying to control the money supply, and interest rates. So it is in fact the Treasury that does the first selling, (and therefore is the one that sells them to foreign governments and others) and the Fed only buys and sells some of them (around 10% most of the time).

Amendment to the last sentence of my second to last post:

"There is nothing inherent in central banking that has to do with debt being the source of value for money." I should probably add something about how all money, no matter what type of monetary system you're operating under, is essentially based on debt, since it is a medium of exchange, and only useful insomuch as people, and or governments, are willing to accept it for the payment of debts.

I think this is where I'm confused...

Here you say: "The only debt involved in this transaction is the debt the Treasury owes whoever holds that bond when it matures."

The principle and interest, right?

And earlier in this thread, you said: "the treasury pays interest on those bonds to whoever ends up holding them."

Now, in my conversation with Withnail, he says "Then the Treasury has to pay interest on these Bonds and then repay the principal amount at the end of their term (which they will probably borrow more money to do thus creating your idea of "perpetual debt"

So it seems that Withnail would be in agreement with those two statements.

Otherwise, I'd have to go back to a question I asked a while ago: Now...if the amount of Treasury Bonds equal the same amount of money, where does the money to pay the interest on those Bonds come from?

If the US issues $100 in Treasury Bonds to borrow $100 in printed (or digital) money, where does the extra say $10 come from to cover the interest? It can't come from taxes, because all taxes have been earmarked for spending...which is the reason for the US to borrow it in the first place.

BTW, I know that the quasi-gold standard nearly bankrupted the US, because for a while there before the end in 73, the US was the only country on the gold standard, so other countries could do arbitrage with our currency and gold and we paid the price.

Ah! Ok! I think I see where the confusion lies!

The Treasury (NOT THE FEDERAL RESERVE) issues bonds to cover the over-expenditures of congress. They might be worth say... $1000 when they mature (lets say for the purposes of this example in 2 years). They sell these bonds, for whatever they can get for them, so... lets say for this example $980. That is what is paid by someone on the open market (again NOT THE FEDERAL RESERVE). In so doing, they are essentially borrowing money from whoever they sell that bond too, in this case they are borrowing $980 from whoever buys it. That could be you, or me, or the Government of France. If they only sold the bond for face value, no one would buy it. What would be the point? Who would bother exchanging $1000 for something else that only had worth as $1000? The time involved in making the trade wouldn't be worth it. Basically they would simply be printing money to cover expenditures. This would pump a huge amount of money into the economy very quickly and cause pretty rapid inflation.

So in our system they borrow $980 from you, with the promise to pay you $1000 in 2 years. Because people beleive in the credit of the United States, and beleive they they will in fact pay that amount when it comes due, people are willing to make that loan, and people are interested in buying and selling those bonds, becuase they are a safe investment. Maybe I know that I'm going to have to pay for a wedding in a year, and you've been holding onto your bond for a year already. I might offer to buy it from you for $985, so I can be sure I'll have $1000 when it comes time to pay for the wedding. You might be willing to sell it because you either think that interest rates are going to go up, and therefore you could use that $985 to buy a more valuable bond, or because you want to buy something right now, and could use the $985, and are willing to forgo the extra $15 in profit because you want to get access to your money now. This is why Bonds can be sold and traded because everyone believes that the Government will pay them off.

The Federal Reserve buys and sells some of them to use as collateral in money creation (we're talking about their main mode of money creation, not the printing of cash, though I suppose a bank might give them a treasury bond as payment for that, I'm not totally clear on the details there), again because they are so reliable, but there is nothing that says the Federal Reserve couldn't buy and sell something else instead to get money into or out of the system, but it has to be something people are wiling to buy and sell at any given time. Basically it has to be pretty reliable. When the Federal Reserve is holding a bond that matures, the Treasury pays them the money, as they would anyone else who was holding it. But in this case, the Federal Reserve only keeps as much of that as they need to to cover their operating costs, and it's reserves for the member banks. It then remits the rest back to the Treasury. In general this means the Federal Reserve remits about 95% of their earnings to the treasury in any given year. Which is pretty close to what it would likely cost the Treasury to simply handle the creation or reduction of the money supply itself.

I think the confusion here stems from the idea that all of the money created in the economy is to cover the difference between taxes and government spending. I don't beleive it is. Instead the Government is borrowing money that ALREADY EXISTS, from people, governments, corporations, whatever. The creation or reduction of the money supply is what the Feds Job is really about. It is tied in some ways to the Treasury's issuance of bonds, but it isn't directly connected to it, and isn't directly related. It's taken me some time to understand this, and I might have a few details wrong, but I'm pretty sure this is basically the way it works.

Congress could in theory authorize the Treasury to simply print more money every time they spent too much, but that would very quickly result in pretty rapid inflation.

From the article I keep quoting: (http://home.hiwaay.net/~becraft/FRS-myth.htm#hd0) (That link is to the summary at the start, but the same bit shows up in the conclusion too).

"The existence of the Federal Reserve is separate from the choice of monetary standard. It is not an alternative to a gold standard. Similarly the existence of the Federal Reserve and the choice of a monetary standard is unrelated to the existence of fractional reserve banking, or to who regulates the operations of banks. The primary issue about the Federal Reserve is about who controls monetary policy."

Hmmm... Actually That may be the first time I've actually quoted that article, not sure, but it is the one I keep mentioning.

"
If the US issues $100 in Treasury Bonds to borrow $100 in printed (or digital) money, where does the extra say $10 come from to cover the interest? It can't come from taxes, because all taxes have been earmarked for spending...which is the reason for the US to borrow it in the first place."

It comes out of the expected growth of the economy. The total value of the economy is constantly rising a result of labour, new resources, and improved technology and productivity. The bonds can be expected to be paid back with interest because the interest keeps pace with economic growth.

At least that's the idea that I have in my head...

Ah-Ha! Thank you DrOct! Very well said! Let me chew on that for a little while and get back to you.

Again, thank you for your input...and thank you for yours, Chris!

@Chrispminis - I beleive you are more or less right. Basically a governent can pay off that debt when it comes due by raising taxes, cutting spending, printing money (this is probably the worst option, and exactly what Weimar Germany tried to do, leading to hyperinflation), or by issuing more debt. Ideally, the hope is I guess, that when it comes time to pay the debt, the economy will have grown enough to provide the tax revenue to pay off that debt.

@Darwyn, I'll say once more, your real problem is with Congress, not with the Federal Reserve. That being said, a little bit of Government debt is not necessarily a horrible thing, but I absolutely agree, that it needs to be kept at a reasonable level, or we do end up in a situation where the government is paying far too much in debt, and can't afford to do much else, or has to default on that debt, and really mess up the worldwide economic system. Spending is the key here. Not central banking.

Just one question...Is the amount of money issued (or loaned) equal to the amount Treasury Bonds at the time of the transaction?

In other words, $100 in money is equal to $100 in bonds. Is that correct?

So the interest doesn't become payable until the bond matures, right?

@Darwyn, Thank you! I would never have come to look as closely at the system, or understand it at the (admittedly still probably fairly superficial) level as I do now, without this discussion!

Something just told me that the system couldn't possibly work the way it was originally presented, or that there must be some bit that we were all missing. It took a long time, and a lot of reading and searching to finally actually figure out even just the gist of how things work.

I'm not sure I understand your last question Darwyn... When the Bond matures, it will be worth $100, but no one would buy it for $100, since they wouldn't be able to get the $100 out of it until it matured, and they could use that $100 now for something else more profitable (like putting it in an interest bearing bank account, or investing it in a company), or just spend it on something they needed.

I think I'm missing something in what you're asking.

Not sure if I answered your question or not, as I don't think I understood what you were asking. Care to clarify?

don't worry...he doesn't either :)

Okay...this whole time, I've been under the impression that if the Government needs say $1000 to cover the difference between tax revenue and spending, it would issue $1000 worth of bonds (with intent on paying $1100 at a later date) and then auction them on the open market to generat the required money.

But here you stated: "They sell these bonds, for whatever they can get for them".

This suggests that a $1 Treasury bond is not necessarily equal to $1 in printed (or digitally created) money from the Fed. So is the Treasury Bond itself subject to market value? Who/what determines the value of Treasury Bonds?

How does the Government know how many Treasury Bonds to issue to cover the PSBR?

"If they only sold the bond for face value, no one would buy it."

What's determines the face value? And, is not the face value the actual amount paid when the Bond is bought, with the expectation that it will be worth a predetermined amount more later?

OR, are you saying that they issue $1000 worth of Bonds (determined by who/what?) and take a lesser amount with the expectation that the Treasury will pay, and only ever pay, $1000 when it matures? But again, how does the Treasury determine how many Treasury bonds to auction to cover spending?

I'll try to sum up my perception of this transaction:

Say I'm the government, and I need money. I calculate revenue from taxes and subtract it from what I want to spend. The difference, say $1000, is the amount that I need to balance the budget.

Therefore, to start the process, I print $1000 worth of Treasury Bonds to auction them.

So using your example, the auction yields, say $900 with the expectation that I will pay $1000 in due time. But how am I going to cover the extra $100 for spending? Does the Treasury print $1100 of Bonds to generate $1000 then? Does it issue more value in Bonds than in the value of money it expects?

Using my example however, the auction would eventually yield the $1000 I need (but with the expectation that I will pay $1100 in due time).

Which scenario is correct?

And THEN what happens? I've issued my bonds, auctioned them and now have the money needed to spend what I budgeted for.

Whereabouts along this transaction does the Fed determine the need to create money if the money I received has already been given to me via the auction?

Withnail, I am SO sorry that I am not an expert at this like you are and that my questions seem demeaning to your very existence. If only my feeble mind could grasp this concept, I'm sure you'd look down upon me from your horse with pride.

In fact, your comments are surprisingly refreshing and have inspired me to allocate what little brain power I have left to understanding what your expertise would surely deem to be SO fundamental that you are completely justified in contributing to this thread, NOT with a calm, objective assessment of the questions, misunderstandings and the genuine desire for knowledge, but in the form of verbal jabs that is obviously meant to highlight the elitist, snobbery that you've come to personify.

Please, at your earliest convenience, let me know when it's appropriate to stand up from my indefinite bowing position.

Thank you.

To be honest... I'm not totally clear on the exact mechanics of selling bonds and determining the exact interest rate that they will carry. I will have to look into that. I just know, for example that if you are given a $100 savings bond, it wasn't bought for $100, but will be worth that (or the treasury will pay that much for it) when it matures. I'm not entirely sure how the initial price is determined (though you mention auctioning, so perhaps it basically works that way, they auction off bonds that will be worth X amount at some point down the line, and let the market determine how much they are willing to pay for them? Perhaps they simply keep printing and auctioning them until they get the amount of money they need to cover the governments expenses? I'm not honestly not sure.) I'll have to do some more research on that part of it and see what I can find out about that.

As to the second part of your question, the Fed uses these as collateral and as a commodity that they can buy and sell in order to control the money supply. As I have said before, it's my understanding that when the Government is issuing these bonds, they are borrowing money that already exists, not creating more to cover government expenses, from the citizens, from other governments, from whoever buys the bonds.

The Fed uses these, becuase they are very liquid and very safe/reliable, as collateral to buy and sell when they want to increase or contract the money supply, (remember they do this by injecting capital into the economy when they buy treasury bonds, which then ends up in banks, which can then loan more, and therefore create more money, or if they want to reduce the money supply, they sell treasury bonds, and therefore take some capital out of the economy, which in turn reduces the deposits in banks, and restricts their lending, which reduces the amount of money).

This increasing and decreasing of the money supply is more or less unrelated (ok, it's not unrelated, since this is the economy we're talking about, but it's not directly related) to the need to cover governments overspending. They use Treasury Bonds, but they could, have, and occasionally from what I understand still do, use other things. The Fed isn't creating money simply so that the government's spending can be covered, it's increasing or reducing the money supply to try to keep the overall economy stable and healthy.

So as I understand it, the debt created by the treasury, is somewhat connected with the Federal Reserve, but isn't DIRECTLY related to the Fed's creating or reducing the money supply. Though I suppose if you traced it back far enough some of the money lent to the Treasury when they are issuing bonds, was probably created as a result of the Fed's actions.

And of course the governments spending/overspending, and borrowing, all certainly do effect the economic conditions in which the Fed is operating, but what I'm saying is that money is not being created for the sole purpose of funding the governments overspending.

Ok. But what is money created for then?