Understanding Money And Government “Debt”


I have just read two small but interesting books by Frank N. Newman, Six Myths that Hold Back America: And What America Can Learn from the Growth of China’s Economy (Dec 6, 2011) and Freedom from National Debt (May 2, 2013).

I am not saying this as a guarantee of anything, but if you look up Newman’s biography by following the links above, you might conclude that he has some very practical reasons to know what he is talking about.

The content of the two books is similar.  There was one epiphany I had in reading the second book, that I did not get in the first book, though.

First, I’ll just tell you the titles of the 6 myths.

  1. Asian nations are bankrolling the U.S.
  2. Treasuries “crowd out” financing for the private sector.
  3. If everyone tries to save more, the nation will save more, and Investment, GDP, and employment will increase.
  4. If the deficit is reduced, then national Saving and Investment will increase.
  5. Deficits create great burdens of repayment and taxes for our children.
  6. If the U.S. does not get its fiscal deficit reduced, U.S. Treasuries will face the same problem as bonds of Greece and Ireland.

If you believe any of these myths, you need to read the book(s).  I am not going to try  to repeat everything in these books.  You really  need to read them yourself.

I will explain, mostly in my own words, I think, one great insight that I got that goes a long way to explaining why all the myths are truly myths.

The first sentence in the next paragraph is my interpretation of what I read.  I do not think either book explicitly said this in exactly these words.

U.S. Treasuries that are sold to the public to finance  government operations should really be considered like bank deposits rather than debts.  We don’t get worried (sort of) when banks receive larger and larger deposits. We usually think this is what makes banks profitable.

Treasuries are like deposits in that people buy Treasuries as a safe place to put their money.  In fact Treasuries are safer than bank deposits, which is the reason people do not get (do not demand) as high an interest rate from Treasuries as they do from banks.  Treasuries are backed by the full faith and credit of the U.S. Government.  Deposits in banks are only FDIC insured up to $250,000.   The primary way that the FDIC insurance “policies” are funded is by money raised from the banks.  However, if a real disaster struck, the ultimate backing for the FDIC is the full faith and credit of the U.S. Government – the same as for Treasuries.

The interest that the Treasuries pay out is then quite similar to the interest that banks pay for the use of your deposits.

The banks earn the money to pay you interest by lending out your money to borrowers who pay higher interest than you get from the bank.

The Treasury uses the money it gets to pay what the Federal Government spends.  This puts your money right back into circulation.  It just occurred to me that instead of the Treasury earning interest from borrowers, the people who receive the money in payment from the government pay some of it back to the Federal Government in the form of taxes. The taxes the government receives is more than enough to pay the interest on all the outstanding Treasuries.

From the book, I learned that there is about a $500billion a day market for Treasuries, so Treasuries are very liquid.  The holders of the Treasuries can get their money back if they need it before the maturation of the financial instruments by selling them on the open market.  When the Treasuries come due, then the Government holds an auction to sell more Treasuries to replace the money from the ones that come due.  A very large fraction of the Treasuries held by the public are just rolled over to the new Treasuries.

Historically, for the last few hundred years ever since the Treasuries were first sold, there are more than enough buyers to buy all the Treasuries that the Government wants to auction off.  So the government never has to come up with USD money to pay off the Treasuries coming due.  It only pays out USD money if it wants to lower the amount of Treasuries outstanding by auctioning off fewer Treasuries than have just come due.

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