Can someone please explain to me under what terms and conditions the central bank can decide to increase the supply of money by printing more notes?
Hazlitt said (in a recent article on mises.org): A budget deficit, however, if fully financed by the sale of government bonds paid for out of real savings, need not cause inflation.
On what basis will new money be brought into existence to pay for t-bonds? How do they decide? Are there limits?
See Rothbard's What Has Government Done to Our Money.
When a regular person buys a government bond, that person is spending money they had to have somehow received beforehand from someone else. That is, it must have been money that was already in circulation. When the Federal Reserve buys government bonds, it really does just create that money out of nothing. This is only possible because the government has succeeded in redefining money to be Federal Reserve Magic Tokens instead of the gold those tokens used to (in theory anyway) represent. Here is a Twenty Dollar Federal Reserve Bank Note from 1929:
http://mises.org/Community/members/hjmaiere/files/twenty.jpg.aspx
On the left it says "THE FEDERAL RESERVE BANK OF MINNEAPOLIS MINNESOTA WILL PAY TO THE BEARER ON DEMAND TWENTY DOLLARS." On the right it says “REDEEMABLE IN LAWFUL MONEY OF THE UNITED STATES AT UNITED STATES TREASURY OR AT THE BANK OF ISSUE." On top it says “SECURED BY UNITED STATES BONDS DEPOSITED WITH THE TREASURER OF THE UNITED STATES OF AMERICA OR BY LIKE DEPOSIT OF OTHER SECURITIES."
The bank note is not money. It is a receipt for money (gold) ‘lent’ to the government. In theory, you were supposed to be able to bring this note to a Federal Reserve Bank and get one of these:
http://en.wikipedia.org/wiki/St._Gaudens_Double_Eagle
In practice of course you couldn't, because the Federal Reserve had issued far more Magic Tokens than they had Double Eagles. So in 1929, when too many people tried to redeem their Magic Tokens for Double Eagles, the economy collapsed. The crash of '29 was not the consequence of ‘unbridled capitalism’ as many a high-school history book put it. It was the collapse of the biggest financial scam in history.
Since government authority serves the banking and mercantile interests first and foremost, the eventual ‘solution’ to the problem was to redefine a dollar to be 1/35th of an ounce of gold instead of 1/20th of an ounce, and then eventually in 1933, to outlaw entirely the use of gold as money by private citizens. In effect, the government worked with the banks to allow the banks to confiscate everyone’s gold. See:
http://www.presidency.ucsb.edu/ws/index.php?pid=14509
When does the printing of the money occur?
"The plans differ; the planners are all alike"
-Bastiat
ChaseCola: When does the printing of the money occur?
http://en.wikipedia.org/wiki/Federal_Open_Market_Committee
But every bank and financial institution that lends money it doesn't have is effectively "printing money." You may have heard of "fractional-reserve banking," but there's also "leveraging." The number of schemes people have invented to 'borrow' and invest money they don't really have is apparently endless. A fun book on the subject is Traders, Guns and Money, by Satyajit Das.
But an interesting example that I only recently figured out and should hit many people close to home: If you have an account with a financial institution that allows you to buy and sell stocks, you probably signed a contract that allows you to effectively borrow against your stocks. You most likely simultaneously gave your financial institution permission to 'borrow' your stocks for other people to sell short. This is what makes it possible for you to sell short stock you don't own. You're 'borrowing' someone else's stock. And they may or may not know that they agreed to let you do this.
And again note that this wouldn't be possible without either the government-imposed use of bank notes as a money substitute, or, as we have now, flat-out fiat currency. From the point of view of the banks, this is of course a good thing. They make money lending money or investing money that they didn't really have. And from the point of view of the government, they get to spend money without the politically inconvenient need to tax or legitimately borrow the money first. The rest of us pay for it with ever-rising prices and 'business cycles.'
So let me get this straight.
The Federal Open Market Committee determine the target for the federal funds rate (depending on how tight or loose they believe monetary policy should be) and then they tell the Federal Reserve Bank of New York whether to buy or sell government securities. Buying brings new money into existence and selling takes it out again.
Is that about the long and short of it?
Can I ask what would happen if government debt was paid off entirely? If there were no government securities to buy and sell, this mechanism for tighening or loosening monetary policy would disappear entirely?
The Fed can affect the money supply by
Even if there was no government debt and hence no outstanding Tbills/notes/bonds the Fed could still easily inflate the money supply buy purchasing any number of things including corporate/municipal bonds, building bridges/roads, or purchasing foreign-government debt. The Fed is becoming increasing creative at finding ways to inflate the money supply (TAFs anyone?), and a lack of bills/notes/bonds to purchase would not preclude the Fed from stealing our money through inflation.
~don
Point 1, adjusting the fed funds/discount rate, is the rate of interest it charges to other banks for borrowing money?
Note that the expression "printing money" is somewhat metaphorical. A physical piece of paper with a number printed on it is equivalent to a number on a computer screen. If the fed lends money to the banks that it has not previously borrowed from anybody, it is "printing" money. The same is true of banks that practice fractional reserve.
The fallacies of intellectual communism, a compilation - On the nature of power
Although I take it that the central bank is the only bank that can use non monetary assets as a reserve for printing more money?
Fried Egg: Point 1, adjusting the fed funds/discount rate, is the rate of interest it charges to other banks for borrowing money?
yes, those are the rates banks pay to the fed and the rates banks pay to each other for overnight loans.
When the Fed lowers rates it encourages banks to borrow more money. This does not necessarily increase the money supply. If the treasury department has a surplus of cash on hand when the loan is made then no new money is created. The problem is that as of today the treasury has a negative ledger balance of about 9.45 trillion dollars.
To service the loan the treasury department has two choices: sell treasuries to investors to raise the cash, or create ("print") new money. While they could sell treasury bills/notes/bonds to get the cash it's a pointless. If someone has money and wants to invest it, and the bank wants to borrow money, then the investor and the bank would rather bypass the treasury and deal directly with each other. The bank is already the financial intermediary between the lender and the eventual borrower.
Also, the main reason that the fed lowers rates is to increase borrowing and thus increase spending/consumption (to "stimulate the economy" in newsfedspeak). Investors buying treasuries are not spending they are saving. If the amount of new savings equals the amount of new spending then there's no net increase in consumption which would totally undermines the fed's reason for lowering interest rates in the first place. Consequently this system only works if the loans are funded from newly created dollars not already existing ones.
It's important to note that even if the loan was made with already existing dollars, it would still inflate the money supply becuase banks do not adhere to 100% reserve banking.
donmc: Also, the main reason that the fed lowers rates is to increase borrowing and thus increase spending/consumption (to "stimulate the economy" in newsfedspeak).
Also, the main reason that the fed lowers rates is to increase borrowing and thus increase spending/consumption (to "stimulate the economy" in newsfedspeak).
Note that this is a smokescreen put up by John Maynard Keynes in 1935, well after the Fed was actually created. The original excusefunction of the Fed was purportedly to allow for 'elasticity' in the money supply. We're not supposed to notice that government debt, in the long run, always grows.
donmc: Investors buying treasuries are not spending they are saving. If the amount of new savings equals the amount of new spending then there's no net increase in consumption which would totally undermines the fed's reason for lowering interest rates in the first place. Consequently this system only works if the loans are funded from newly created dollars not already existing ones.
Investors buying treasuries are not spending they are saving. If the amount of new savings equals the amount of new spending then there's no net increase in consumption which would totally undermines the fed's reason for lowering interest rates in the first place. Consequently this system only works if the loans are funded from newly created dollars not already existing ones.
More accurately, a new economic myth was carefully crafted over the years and promoted by the banks and government that just happened to argue that the only solution to the problem of panics/depressions/recessions/slow-downs required the creation of money for the government to spend, which is what the true first function of a central bank is and always has been. (The second is to make the bankers themselves rich by cartelizing bank note issue.)
I am aware of the pyramid effect but I still do not know the process for the physical printing of money, anyone know?
ChaseCola: I am aware of the pyramid effect but I still do not know the process for the physical printing of money, anyone know?
As far as I know, the Treasury Department runs the printing press. They sell the FED the paper currency at something like $.06 per note...IRONY! Even though the FED buys the notes, they are meaningless and could sit in a warehouse. I'm sure it is illegal for the FED to simply start spending them. If they did, we'd see a much faster rate of inflation, IMO, and the government would probably get flak for such an arrangement. They cannot be claimed as an asset on their balance sheet, either (not sure about that...if they could, which seems fishy, I assume it is at the market price [$.06/note] rather than the legal tender price). The Treasury probably receives currency requirement estimates from the FED to do its printing. Should it ever exceed what the FED demands, then it just holds the notes. I am not sure whether or not the Treasury can refuse to print more federal reserve notes.
Basically, the paper is there just in case one of its member banks needs additional currency. The member bank would receive the paper and the regional Federal Reserve Bank would decrease that bank's reserve account by the appropriate figure. There is most likely a fee charged to the bank for the delivery as well.
In other words, printing money is NOT creating money. Nearly all money creation is done by the FED simply increasing the account balance of one of its clients (government, primary dealer, foreign gov't). The paper is there for when it is needed to satisfy demand for currency from an already credited account. **Please correct me if this is wrong**
I have a couple different question for this discussion:
1) When the FED buys treasuries, who is actually paying for it? Would this be a regional FED Bank, thus financed by that region's member banks? If it buys them by simply creating new money and it is a single regional bank that does the creating, how does the entire system determine which region gets to do the creating. It seems one region's inflation would hurt another region's loans; thus, is there some kind of inter-FED auction whereby the creator pays out to the other regional banks?
2) When the FED buys treasuries, it credits the government's account. Is the gov't's account held with a regional FED bank, or is it a seperate entity tied to all regional FED banks?
3) Who gets to determine who gets to be a primary dealer? When and why are primary dealers middle-men between the gov't and the FED's open market ops in purchasing gov't securities?
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Well, yes but it is not so much the printing of the money rather than the system.
Fractional reserve works like this.
The central bank requires from every other bank to keep a fraction of the assets it has as a reserve by depositing it into an account the bank holds with the central bank. Let's say it is 10% - in the Euro-zone it is 2% in fact-.
If a bank wants to borrow $1000 from the central bank, it has to deposit $100 into the central banks account, leaving $900 for the bank to further lend out. Now the bank lends out the $900 to a customer. The customer pays with those $900 a bill by transfering the money to an account held by the same bank. Now the Bank has another $900 of which 10% has to be made into reserves. The bank can lend another $810 to someone else (900 - 10%). This game goes almost ad infinitum although with constantly decreasing amounts.
As you can see, the bank by lending $1000 from the central bank can itself lend out much more than the original $900. Actually this scheme comes close to a pyramid system and can only be supported as long as new money is printed.
In the begining there was nothing, and it exploded.
Terry Pratchett (on the big bang theory)