I was struggling hard to understand sustainability of money creation. Hope you wouldn’t mind reading below and hope some can shed some light on the logics:
Time zero, a certain M0 exists. Banks lend and borrow and creates credit money.
Treaury borrows from public and issue gov’t securities.
Fed enters repos to buy gov’t securities, thus increasing M0
Repos expire, Fed sells back the securities, M0 decrease. With interest, M0 is lower than the level before Fed’s repos purchase.
Fed uses outright purchase of gov’t securities to permanently raise M0.
Fed’s held gov’t securities matures. Treasury has 2 choices (1) raise tax and pay back the fed. M0 decreases. Again, with interest, M0 is lower than the level before Fed’s outright purchase. Or (2) issue gov’t securities again to borrow from public to pay back the fed. This drains down M0. Fed then uses repos/ outright purchase again to monetize the gov’t securites and increase M0.
Is the above correct?
If so, it means the Treasury needs to create bigger and bigger debts for Fed to monetize in order to (1) pay off old debt held by Fed (2) pay Fed interest and (3) enable a growing M0.
This means to keep M0 growing, gov’t debt MUST balloon. This is a mathmatical limitation. The debt will then become out of proportion to the M0 and the GDP and the natural productivity of the system. Interest rate will become very high for the gov’t to borrow. Gov’ts are forced to raise tax to pay back the debts. Markets will collapse with the combination of high interest rates and high tax rates. All would collapse till the gov’t debt level is bearable again. Then, the gov’t continue to borrow again. Fed continue to monetize again until the debt grows big and it collapses again.
Is this correct?
If so, it means there is a natural limit to M0. The limit will be a combination of M0 created by the old days gold standard plus the ability of the gov’t to borrow and fed to monetize debts without bringing down the system.
Even with the current credit crunch, we probably have not reached the natural limit of the monetization process as US Public Debt / GDP ratio is around 80% as opposed Japan Public Debt/GDP ratio of 150%
What we see in the last century has been an economic expansion driven by an on-going expansion of the monetary base through monetization of an ever-growing gov’t debt. . US can also issue longer dated gov’t bonds to further delay the problem.
But sometime in the future, the system has to come to a halt when gov’t can no longer borrow more or choose not to borrow more. Then money base has to contract or a new way besides monetizing gov’t debt is needed to raise MO.
I’m not sure about other central banks, but the Federal Reserve can expand the money supply directly via two ways:
The Discount Rate - this is the rate at which the Fed lends money to member banks.
Open Market Operations - this is the buying and selling of securities. Obviously, the Fed needs to buy more and more securities to continually expand the monetary supply. Repos are obviously a part of open market operations.
That said, I don’t see what your point is about the natural limitation of M0. Treasury debt isn’t the only debt that is securitized and sold to the Fed. Also, money can be lent to member banks and member banks receive a 6% dividend. If we have continual monetary expansion, of course we are going to have to have more debt to continue monetary expansion. The whole thing is that if there is more money, we will have more nominal debt anyways, because money will be worth less.
I am trying to understand if the current monetization of public debt as a policy to grow money supply is sustainable or if there is a mathmatical limitation.
Assume on day 1, MO is 50 dollars created by gold deposit at the fed from old days. That’s all we have in the system.
In period 1, Treasury then borrows all 50 dollars (This has to be M0 effectively). Fed monetizes the 50 dollars debt. We have 100 dollars M0 and 50 dollars public debt.
In period 2, Treasury needs to borrow say 51 dollars to pay back Fed, 50 dollars principal 1 dollar for interest. Fed again monetizes this 51 dollars debt. Now, the system has M0 of 100. (begining 100 - 51 borrowed by Treasury to mature debt held by Fed +51 new M0 created by Fed.) And public debt is 51 dollars. So, the public debt to M0 level rises from 50% in period 1 to 51 % in period.
As Treasury borrows more to fund the payback of debt held by Fed, would it come a point that public debt to M0 level is too high for any new funds to be borrowed to pay back Fed?
If so, Treasury will need tax to pay back Fed. Then M0 will fall till Treasury can borrow again. By then, the cycle of monetization of public debt will fall and system will contract.
ALTERNATELY, we will then need a new way of monetization. E.g Commercial bills. But sooner or later, similar constraint will be met.
Then, the ultimate öutcome of the system is for Treasury to borrow from Fed directly to keep on rolling over the old debts and to fund budget deficits? Essentially, Treasury and Fed will cooperate or more like engage in collusion to keep on injecting M0 to the system?
You’ll understand it just fine if you just keep this one thing in mind: The Federal Reserve System, as with all central banks or otherwise institutionalized fractional-reserve banking, is a scam. It’s a scam designed to sustain an inherently-insolvent system wherein banks earn interest off of money that is not theirs to lend, and governments can expand while hiding the true cost of their operations from the public, because they no longer have to rely on direct, open taxation to fund them (inflation is a hidden, more insidious form of taxation).
Also, the nature of the system is to keep the citizenry in a perpetual debt trap. The bankers and movers who sit at the top have a steady, uninterrupted flow of wealth allocated to themselves, because the entire financial system is utterly dependent on debt to sustain itself, and they are the prime “creditors,” whose sole claim to “interest” payments is that they are smart enough to swindle the public without enough people catching on to their scam.
I did a bit more searching on the internet and I found the below:
FED maintains a System Open Market Account for outright purchase of gov’t securities. This is for a permanent increase of M0 (banks deposits at fed) in the system. Such holdings will be rolled over forever while FED may also redeem some holdings to reduce M0 permanently. Also any interests earned by FED are used to pay FED expenses or attributed back to the Treasury and therefore do not drain any M0 from the system.
So the system is sustainable then. So long as Treasury continues to borrow, FED can monetize the debt to increase M0. This monetization is equivalent to forgiving debts by printing money. The happy problem of the potential not having enough Treasury back in the Clinton’s days is no longer the case now.