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All rates on US Treasury Securities, regardless of maturity, are indirectly set by the Federal Reserve
While not its explicit policy, by setting the overnight rate and various direct lending rates, the Fed determines the nominal yields on all US Treasury Securities
Quick Lesson: We use what are called Primary Dealer Banks as middlemen between two branches of government: the Federal Reserve, and the US Treasury. These PD banks can borrow from the Fed at one rate, and lend to the Treasury at a higher rate. This is silly and totally unnecessary, and represents yet another form of Wall Street Welfare (Marriner Eccles called it hocus pocus back in the 1940s!) Nevertheless, as long as you understand this arrangement, you can understand that the Treasurys account can never be short of funds
The Fed generally likes to make direct borrowing a little more expensive than borrowing in the funds market, especially recently Starting in 2008, Interest on Excess Reserves (IOER) changed the game in the fed funds market, while the discount process remained similar Some spread remains due to counterparty friction and because FHLBs cant get IOER Since 2003, financially strong and well-capitalized banks can borrow under the Discount Window primary credit program at a penalty rate above the target fed funds rate (rather than a subsidized rate, as in the past). For banks eligible for primary credit, the new DW is a noquestions-asked facility. Namely, the Fed no longer establishes a banks possible sources and needs for funding to lend under the primary credit program. Instead, primary credit for overnight maturity is allocated with minimal administrative burden on the borrower.
Comparing Rates
So lets compare rates that we know the Federal Reserve controls directly, with interest rates on US government debt, known as Treasury Securities Both the Treasury and the Federal Reserve create liabilities:
Fed liabilities are called reserves, and can be withdrawn from the banking system as Federal Reserve Notes (cash). They do not bear interest
Treasury liabilities are Treasury securities, and do bear interest
All that monetary policy involves is swapping one liability for another
The US Treasury issues several types of these securities, with varying maturities and coupons.
Comparing Rates
As we will see, both types of government liabilities are closely related Think of it this way: Treasury Securities are to reserves, what ice is to water
A security, like ice is a less liquid form of the same thing Just as water expands when it freezes, dollars in treasuries expand through coupon and interest payments
For this exercise, well take a look at the 1-month, 3-month, 6-month, 5-year, 10-year, and 30-year securities Keep a close eye on how rates on these Treasury securities compares to the Federal Funds rate
Example #1
Lets start with a short term security, such as the 1-month note:
The FF acts as ceiling to the 1 month rate, since Fed Funds are uncollateralized
If I had not used different colors, you probably could not have seen the difference
Here, we can see some pricing of 5 years worth of inflation risk against an overnight rate, but the price still follows the funds rate neatly
A little more risk, a little more expensive. But still, follows the Fed! However, there is enough daily noise to lead people to miss this crucial fact. This is why the long picture is so important!
All of these nominal yields follow the Federal Funds Rate Markets do a little pricing, but the Fed is always in the drivers seat
An everyday comparison
Think of it this way: Treasury Securities are just time deposits at the Fed, like a Certificate of Deposit is a time deposit at your bank. Just as longer CDs have higher rates; longer Treasuries have higher rates
Federal Funds are like a checking account (demand deposit) at your bank. Since it is the most liquid, it has the lowest yield.
All Treasury Securities are just priced out of that overnight rate. The longer the term, the higher the yield (FF rate+time)
The Fed always buys bonds to hit its target rate, whatever that may be The rate is voted on by the FOMC, the members of which are appointed by the US President and confirmed by the US Senatenot markets, bond vigilantes, the Chinese, or whatever
helicopter drops
Rates
Debt
Because WE issue our own fiat currency, WE get to decide how much interest, if any, to pay on it
Not Wall St., not foreigners, not markets, not bond vigilantes Thats what it means to be a monetarily sovereign government
Say it with me: Uncle Sams a money sovereign, markets dont tell him what he can spend! Congress does!
A government that adds, not subtracts to the wealth of its citizens when it deficit spends.
You still think the Federal Government can run out of money?
Really?
This building
is named after him (the Fed Board of Governors building on Constitution Ave)
So it is illusion to think that to eliminate or to restrict the direct borrowing privileges reduces the amount of deficit financing. Or that the market controls the interest rate. Neither is true. The facts of the matter are that the Federal Reserve System gets practically all of those bills every week, through an arrangement with the Government bond dealers, to put bids in at 3/8ths, with complete protection by the Reserve banks to take them off their hands before they even pay for them. This is what we call hocus-pocus, and we are of the opinion that we could exchange directly with the Treasury
More evidence
Further argument form Beardsly Ruml, Chairman of the New York Fed in 1946:
Eccles laid all this out during his tenure at the Fed. Unfortunately, most of his words have long since been forgotten.
For more Eccles documents, go to fraser.stlouisfed.org/eccles
The Federal Reserve is independent in the government, not of the government There is no reason to pay banks a commission to serve as middlemen between inter-agency, intra-governmental transactions. While statutory changes would be ideal (i.e. HVPCS, direct unlimited overdraft authority), we feel that in the short term, mere rhetorical changes could suffice.
The word deficit is itself very prejudicial. Americans have been trained, like Pavlovs salivating dogs, to elicit fear at the mere mention of the word. It implies some sort of lacking or running out of things, which as we know has no relevance to federal finance, so
We strongly suggest using these terminology updates:
Instead of deficits or borrowing, say net financial injection or net financial assets
Instead of spending say federal deposits Instead of debt say risk free savings accounts or simply Treasury Securities
Terminology Updates
So lets stop using self-defeating, fearful rhetoric like
out of control debt skyrocketing debt
crushing debt
Pay China First Only fires, wars, climate change can get out of control. Digital balance sheets cannot get out of control! We need to use MMT to deploy a fierce practicality on fiscal issues to counter all the right-wing deception Right-wingers feed on fear and confusion, so we have to stop using confusing terms ourselves
Bond markets do not get to discipline our US government; the Chinese to not get to discipline our US government; Wall Street banksters do not get to discipline our government. Only we the voters get to do that. Thanks to the genius of the founding fathers, our participatory democratic form of government has been Constitutionally vested with the monopoly power of currency issuance.
No Chinese Shylock is going to sail across the Pacific demanding a trillion pounds of American flesh. It just doesn't work that way. We are Americans, and only we can control our economic destinies. The Chinese dont command the US Treasury anymore than Chinese generals command the US Pentagon. Do US soldiers take orders from Chinese military leaders? Of course not, and the Treasury/Congress does not take orders from Chinese bankers.
Therefore, for the purposes of clarity, we believe that there is no reason why any supreme, sovereign government should be issuing debt at all. Instead, such governments should be issuing debt free currency, that could be identified, or at least thought of, as equity. The US government did this previously during the Civil War, when Abraham Lincoln ordered the Treasury to issue its own, debt free currency known as United States Notes. The Treasury continues to do this in limited form every time it mints coins and assigns them value. Thomas Edison in 1921: If our nation can issue a dollar bond, it can issue a dollar bill. Both are promises to pay, but one promises to fatten the usurers and the other helps the people.
Nearly every publicly traded corporation funds itself through a mix of debt and equity issuance; why should the federal government not do the same? US dollars could be referred to as American Equity, and would represent a nominal claim to the massive production power of the United States economy.
Further, direct creation of reserve balances would actually be less inflationary than the current system of security issuance. Reserve balances, unlike securities, are inert forms of government liabilities, because they do not continuously pump coupon or interest payments into the economy.
So how could we go about doing this? Well the answer is, we already have, during World War II. Along with other New Dealers, Federal Reserve Chairman Mariner Eccles ushered in the era of modern public finance
Due to emancipation from the gold standard and Mr. Eccles leadership, this was one of the first times in human history where a nation at war ran out of real resources before it ran out of money. Finally freed from self-imposed financial constraints, this new approach to public finance allowed the allies to produce a war machine of unprecedented size and strength:
http://youtu.be/l2ECyYHPnhg?t=2m43s
We strongly feel that the enormous 21st century challenges of income inequality, middle class collapse, and global climate change cannot be sufficiently tackled until the how do we pay for it question has been fully answered, and only MMT has that answer.
We can both succinctly describe the operational realities of the current system, and suggest updates; we can provide both short term patches, and long term paradigm changes, and we have the academic backing and persuasive materials to make a bulletproof argument.
Sources
Federal Reserve Economic Data (FRED), Federal Reserve Banks of St. Louis Recent Developments in Monetary Policy Implementation by Simon Potter, Executive Vice President, Remarks before the Money Marketeers of New York Marriner Eccles Testimony- Direct Purchases of Government Securities By Federal Reserve Banks. Hearing before the Committee on Banging and Currency, House of Representatives (1947) Can Taxes and Bonds Finance Government Spending? By Stephanie Bell, July 1998
The Greatest Myth Propagated About The Fed: Central Bank Independence (Part 2), L. Randall Wray, January 2014
Soft Currency Economics II, Warren Mosler, October 2012 Liberty Street Economics, Blog from the FRBNY