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Roger Sparks said: "Of course, the Fed has no money except what it prints or keys."

And, "I think the scale of purchases is vastly larger than the interest the Fed earns. From the Federal Reserve Data Series 'MBST', the purchases were about $1.7 trillion over 5 years."

The last paragraph is probably true.

It seems to me the fed could have "money" from capital gains and/or interest/dividends from its assets.

Csissoko,

Maybe we are saying the same thing, but Nick asks why do we need both red notes (debt) and green notes (money). I would say that even in a barter economy without green notes you still need debt to overcome the production schedules of different goods.

Without money, if I have apples I can deliver in 6 months and my neighbor has an airplane he can deliver in 2 years, I would lower the number of apples I offer for his airplane the reflect default risk I am taking. In essence I would be collecting 1 1/2 years of "apple interest".

Oliver said: "What's your question? Is the exchange rate 1:1 by chance? No, it's a peg to the medium of account. One could also say a franchise of the medium of account."

If something is medium of account and something else gets fixed/pegged to it, then I am going to say that something else also becomes medium of account.

Agree?

Also, I say are currency and demand deposits are fixed to each other both ways. Nick says it is only one way.

Here is how I would look at it. Assume $7 trillion in demand deposits and $0 in currency. Velocity (V) is 2. NGDP is $14 trillion. Now have entities start borrowing so that M (demand deposits) starts going up 20%. Assume V goes to 98% of 2 (1.96). That means NGDP is up by approximately 17%. Let's assume 15% is price inflation. M is falling in value relative to goods/services. However, since demand deposits are "money", prices rise. Next, people start wanting to hold currency instead of demand deposits (bank run). The fed would allow currency to go to $8.4 trillion. The fed never says we won't allow that exchange so that currency would appreciate in value relative to demand deposits. Prices of goods/services both rise by the same amount at stores. It is not one price for currency and one price for demand deposits. Fees do not count.

Also, the fed does not raise the fed funds rate to keep people from wanting more currency. The fed could raise the fed funds rate. However, it would be more about more saving, less borrowing, and possibly narrowing spreads between short-term and long-term interest rates.

Oliver at 11:20 said: "The CBI has monopoly on issuing notes and coin. Coin is manufactured for the CBI by the Royal Mint, and notes by a specialist printer in the United Kingdom."

I would actually say the gov't has a monopoly on issuing notes and coin. The gov't has allowed this to be turned over to the central bank. It seems to me the central bank has a monopoly over central bank reserves.

Think of it like this: central banks have not always existed. Notes and coins are a liability to what entity then when there is no central bank?

TMF

I don't think it's that important. All sides have their roles and in the end it's a bit like asking whether you or your boss are responsible for your work output. Define responsible.

My take is that prices are initially set as a product of investment decisions made between investors and commercial banks. These then pan out in a certain way, depending on the success of the investments, which also depends on the propensity of consumers to save in deposits. Governments can influence this process by stepping in as investors (of last resort), thus filling the output gap. CBs can also step in before the fact by influencing overall lending volume through interest rates and by setting and enforcing lending standards. But they can also step in after the fact by buying / selling risky assets (products of previous investments!) in exchange for their own liabilities.

Importantly, the latter operation, as well as emittance of coinage and CB notes are always preceded by private / government borrowing activity. CBs do not take part in this. Governments are like private investors, albeit usually with special privileges.

Oliver said: "I don't think it's that important."

I assume you mean the discussion about demand deposits and currency. It is of paramount importance on this blog.

Nick says the commercial banks with demand deposits need to keep the demand deposits at the same value as currency in terms of the prices of goods/services because the central bank sets the price inflation target. He says demand deposits are medium of exchange (MOE). I believe he also means demand deposits are NOT medium of account (MOA). The central bank is alpha, and the commercial banks are beta.

I say demand deposits are both MOE and MOA because the fixed exchange rate happens both ways. The commercial banks and the central bank are both alpha. If price inflation is too high from demand deposits, the central bank does not deny the fixed 1 to 1 convertibility thru the commercial banks.

It is not like a foreign country that fixes its currency to the dollar. That is only one way. In the USA, stores have the same price of goods/services for demand deposits and currency (fees do NOT count). In a foreign country, prices of goods/services may be different for "dollars" and the foreign currency. This usually happens when the foreign country is forced to abandon the one way peg.

Frank said: "Why would someone steal your red money? Because he / she wants to sell a good and can't find enough buyers with green money, so he / she steals your red money and then "sells" the good by transferring both the good and the red money to the buyer."

Possible scenario: Someone has 10 goods as assets. That person steals 10 red notes/green bonds. They don't take over red note/green bond as a liability (theft). No change in equity. If someone steals green currency, there is a positive change in equity for the thief. That person sends 10 goods and 10 red notes/green bond onto a 3rd person.

At the end, the thief has 0 goods as assets. Overall, equity went down to 0. I don't see that happening.

I believe the same scenario applies if the thief assumes the red note/green bond as a liability and then moves both 10 goods and 10 red notes/green bond onto the 3rd person.

http://worthwhile.typepad.com/worthwhile_canadian_initi/2014/02/colateral-and-the-money-supply.html

"Now suppose the central bank pays interest Rg on holdings of that currency, and can vary that rate of interest. (If you hold 100 green notes, the central bank gives you Rg more green notes every year.) An increase in Rg increases the demand for currency, and if the supply of currency is fixed, and if prices are sticky, this excess demand for currency would cause a recession.

Now suppose we add a second form of central bank currency. Red currency has negative value."

And, "I think the ECB has a rule which says the total stock of green money must equal the total stock of red money. (JKH?) In other words, the ECB is a New Keynesian central bank. That's a problem for the ECB.

I'm not sure if I have got this right, but my head hurts, so I am going to post it."

This post: "What happens when we introduce overdrafts into an economy with 100% reserve banking?

There are green notes worth +$1 each and red notes worth -$1 each."

Let's go over "What happens when we introduce overdrafts into an economy with 100% reserve banking?"

https://www.chase.com/checking/overdraft-protection

"What it is:

Overdraft Protection helps you avoid overdraft fees when you don’t have enough money in your Chase checking account by the end of the business day Footnote 1 (Opens Overlay).

How it works:

•An automatic transfer (if funds are available) from your Chase savings Footnote 2 (Opens Overlay) or Chase credit card account Footnote 2 (Opens Overlay) to your Chase checking account will be made at the end of the business day.
•The transfer is generally made in $50 increments to cover your transactions and the Overdraft Protection Transfer Fee (for example: $50, $100, $150).

How much it costs:

There is no fee to enroll; however, each day we make a transfer, you will pay one $10 Overdraft Protection Transfer Fee Footnote 3 (Opens Overlay). If the transfer is from your credit card, you will also pay interest from the date of the transfer. We will not charge an Overdraft Protection Transfer Fee if your ending account balance, before any Overdraft Protection transfers are made, is overdrawn by $5 or less or the Overdraft Protection transfer resulted from transactions that are all $5 or less."

That means using green demand deposits by issuing a green bond (credit card) or using existing green demand deposits. No red currency.

https://online.citibank.com/US/JRS/pands/detail.do?ID=CheckingPlus

"What You Get

Checking Plus® automatically transfers funds from your credit line to your checking account to cover your overdraft plus any fees.2 That means no more bounced checks!3

If there's an outstanding balance on your Checking Plus account, the minimum payment is automatically deducted each month from your linked checking account. It's that easy.

How It Works

The amount transferred is rounded up to the nearest $100, so you have extra protection if other overdrafts occur. You also can borrow funds from your Checking Plus® line of credit directly OR transfer funds from Checking Plus® to any linked account, such as checking, savings or a money market.

Don't need the extra coverage? Just transfer funds from your checking account to pay back your Checking Plus® advance.

To qualify, you must have an annual income of at least $10,500. You must have and fund an eligible Citibank deposit account (e.g. checking, savings, CD, or money market) with at least $1 within 21 days from the date of application."

That means using green demand deposits by issuing a green bond (credit card) or using existing green demand deposits. No red currency.

I am not sure if the ECB is a New Keynesian central bank or not. I am pretty sure New Keynesians would talk about green "money" and green bonds, not red currency.

The ECB takes in bonds or bond-like instruments from the commercial banks for overdrafts. The ECB does not issue "red currency" as another liability.

Red currency does not exist in the real world.

"Suppose we stop keeping our money in our pockets. Instead we each have a box with our name on it at the Bank of Canada, where we keep our paper banknotes issued by the Bank of Canada. When I buy something from you, I send an email to the Bank of Canada, cc'ing you, instructing the Bank of Canada to take a $20 banknote out of my box and put it in your box. The Bank of Canada sends a reply-all email confirming it has done this. Then the boxes and paper banknotes all get destroyed in a fire. But it doesn't matter because the Bank of Canada has a computer record of how many notes are in each person's box, so everything carries on just as before. Paper money that we keep in our pockets is functionally equivalent to electronic money, except for convenience, muggers, etc.

100% reserve banking is exactly like that (all money is central bank money), except that there is limited decentralisation so that commercial banks manage some of the record-keeping and communications. Most proposals for 100% reserve banking require each commercial bank to keep a record of how much is in each customer's box, and the central bank to keep records of the totals for each commercial bank (with an occasional audit to check that the two sets of records match up). Frosti's proposal requires the central bank to keep records of how much is in each individual's box too (the commercial banks just handle the communication)."

I don't believe all money is central bank money is the correct way to look at 100% reserve banking. I think it is better to say 100% reserve banking means every commercial bank demand deposit has to have a central bank reserve backing it.

Bank of Canada part ---

If we deposit currency at the Bank of Canada, the currency goes back to it (the currency becomes the Bank of Canada's asset). The currency would go in the Bank of Canada's box (vault cash), not the depositor's box. Demand deposits (assets of the depositors) go into the depositor's box. Checks are then instructions to move demand deposits by taking a $20 demand deposit out of my box and put it in your box. The demand deposits are moving/have velocity, not the $20 in currency/vault cash.

TMF,

"That person sends 10 goods and 10 red notes/green bond onto a 3rd person. At the end, the thief has 0 goods as assets.... Overall, equity went down to 0. I don't see that happening."

Consider that many goods that are produced have liability like qualities.

Many goods depreciate over time. A warehouse full of apples becomes will eventually become a pile of rotten mush. Also, warehousing space is typically limited and so unsold goods can constrain new production.

Obviously, stealing red notes and using them to complete a sale is effectively selling goods at a loss. But selling goods at a loss is sometimes more cost effective than shutting production down and then trying to restart it.

"Obviously, stealing red notes and using them to complete a sale is effectively selling goods at a loss."

Exactly.

"But selling goods at a loss is sometimes more cost effective than shutting production down and then trying to restart it."

That would depend on things like is demand temporarily down and/or shifting production to another variety.

TMF,

More to the point, it would depend on whether demand is down because of liquidity constraints of potential buyers.

Having a producer steal red notes to sell goods to potential buyers is a solution to alleviating the liquidity constraints of those buyers.

The question then becomes, does the stealing of red notes violate the property rights of the original owner? What if the taxing authority accepted either green or red notes as means of satisfying a tax payment?

Red notes would then would have negative value in the sense that they count as debts that must be retired. But they would also have positive value in that they are both a means of exchanging goods (positive liquidity value) and a means to pay taxes (positive legal value).

Imagine two producers - one with goods to sell and a lot of red notes, one with goods to sell and no red notes. From a balance sheet perspective the producer with goods to sell and no red notes is in a better economic position. From a liquidity perspective the producer with goods to sell and lots of red notes is in a better economic position.

And so judging the health of a company gets hazy when consideration must be given to both the liquidity of the company and it's profit / loss statement.

Nick said: "A financial asset is just a bit of paper (or plastic, or silicon nowadays) with some sort of IOU (or promise) written on it. Nowadays (nearly?) all money is IOUs (but not all IOUs are used as money). Bank of Canada currency is an IOU, but it's a strange sort of IOU. The promise (though it's written on the BoE's website, not on the currency itself) says (roughly): "We promise to make this bit of paper/plastic depreciate at roughly 2% per year against the CPI basket, unless we change our minds. Signed Steve and Carolyn."

I think currency is such a "strange sort of IOU" that it should not be considered an IOU at all. Currency is more like a commodity with relative prices vs. other goods/services.

TMF
Start at t=0 with a blank slate. My neughbour has built an extra house and I need one because I can't get my business started in a tent. So I go to a bank and borrow the money to buy the house. My debt signifies that which I must contribute to GDP in future whereas the miney signifies that which my neighbour has the right to buy once it's produced and on offer. It clearly is an IOU and corresponds 1:1 with the debt principal. When I then sell the produce if my business to my neighbour, I can repay the loan with the proceeds. Both debt and money disappear. That is not how commodities behave.

"More to the point, it would depend on whether demand is down because of liquidity constraints of potential buyers."

What if the buyers are income constrained?

"What if the taxing authority accepted either green or red notes as means of satisfying a tax payment?"

I doubt that will happen. Accepting red notes/green bonds means the gov't is going into debt.

The biggest problem with red notes/green bonds is debt defaults.

Oliver said: "So I go to a bank and borrow the money to buy the house."

And, "Both debt and money disappear."

When you go to a commercial bank, you borrow demand deposits. The bond is an IOU. I can see the demand deposits being an IOU.

Think of an economy with no debt and no demand deposits. There are just savings and income. Currency is MOA and MOE. The currency printing entity has an intangible asset(s) backing the liability (currency).

Now replace currency in that scenario with gold (a commodity).

What is the difference?

Oliver and Frank, my guess is Nick is reading these comments and thinking we are totally missing his point.

Oliver and Frank, what do you think are in the "boxes" of the customers at either commercial banks or the imaginary central bank? Demand deposits or vault cash/central bank reserves?

TMF,

"What if the taxing authority accepted either green or red notes as means of satisfying a tax payment?"

"I doubt that will happen. Accepting red notes/green bonds means the gov't is going into debt."

And governments never go in debt? And besides, if a government is accepting red notes as a form of tax payment, there is nothing stopping that government from bequeathing those red notes back to the tax payers as a method of redistribution.

"Oliver and Frank, my guess is Nick is reading these comments and thinking we are totally missing his point."

I don't think I am. Nick has not established how a central bank shrinks the quantity of total liquidity (red notes + green notes) without violating the property rights of green note holders. Sure I can choose to pay off my debts (red notes) using green notes, but Nick allows us to use red notes as a medium of exchange, so it is not necessarily in my best interest to ever retire my red notes. The only thing I might need to do is maintain a positive / zero balance of goods + green notes relative the quantity of red notes that I have.

One way to retire red notes is through traditional fixed term debt (red notes). Another is allowing the government to accept both red notes and green notes in the payment of taxes. Government retires equal portions of whatever red and green notes it receives in taxes by sending both back to the central bank.

That is why I brought up red note payment of taxes. It allows a consolidated government / central bank to regulate total liquidity (red notes + green notes) if red notes (debt) is perpetual rather than fixed term.

TMF,

http://en.wikipedia.org/wiki/Jubilee_(Christianity)

In Judaism and Christianity, the concept of the Jubilee is a special year of remission of sins and universal pardon. In the Biblical Book of Leviticus, a Jubilee year is mentioned to occur every fiftieth year, in which slaves and prisoners would be freed, debts would be forgiven and the mercies of God would be particularly manifest.

Why wait for every fiftieth year? Consolidated central bank / government is able to retire / redistribute debts (red notes) every tax season.

TMF

My original point was that I think it is silly to think of money and overdrafts separately because they are two sides of the same deposit.

The reason I come to this conclusion whereas others such as Nick don't, is that I consider that demand deposits are actually money (alpha) whereas coins, notes & reserves are beta, in that they come logically afterwards. In fact, I'd go so far as to say they're gamma, because what comes first is investment / production. Money is just a byproduct of distribution. It keeps track of who's ahead and who's behind in using / producing real goods for the economy.

Think of an economy with no debt and no demand deposits. There are just savings and income.

To my mind, that doesn't make sense at all. How is income produced if not through a banking system? You can realistically posit an economy without a CB, but I cannot fathom a modern economy without some kind of banking system. It can be state run and have arbitrary limits on the amounts of money it may emit, but it's still a banking system, albeit a communist / command economy one. You somehow want management and compliance without the company.

I don't agree with Nick's position on what money and the supposed powers of the monetary authorities are. But as opposed to your story, his seems at least internally consistent.

Oliver, there are no commercial banks and no central bank along with no debt and no demand deposits.

The treasury issues currency which is its liability. The currency is not "redeemable".

There is no debt production. There are no payment settlements. Stock(s) can be issued. Everyone uses currency as MOA and MOE (buying and selling for it).

If there is a shortage of currency, the treasury just issues more of it and finds a way to get it into the economy. I would not consider that a "banking system".

"The reason I come to this conclusion whereas others such as Nick don't, is that I consider that demand deposits are actually money (alpha) whereas coins, notes & reserves are beta, in that they come logically afterwards. In fact, I'd go so far as to say they're gamma, because what comes first is investment / production. Money is just a byproduct of distribution. It keeps track of who's ahead and who's behind in using / producing real goods for the economy."

I'd say demand deposits and currency are "alpha". What if the fed did QE with currency?

Let's assume my all currency economy. As far as gamma, what if some entity decided to save using currency as the savings vehicle? Now there will be probably be a shortage of currency. More currency is needed even though production was unchanged.

Frank said: "And governments never go in debt? And besides, if a government is accepting red notes as a form of tax payment, there is nothing stopping that government from bequeathing those red notes back to the tax payers as a method of redistribution."

The problem with sending red notes/green bonds back to the taxpayers is debt defaults. If there were never any debt defaults, most of the problems in an economy would probably not occur.

And, "I don't think I am. Nick has not established how a central bank shrinks the quantity of total liquidity (red notes + green notes) without violating the property rights of green note holders. Sure I can choose to pay off my debts (red notes) using green notes, but Nick allows us to use red notes as a medium of exchange, so it is not necessarily in my best interest to ever retire my red notes."

I believe that Nick specified red notes as red currency, meaning liability of the central bank. We are saying red notes as green bonds, meaning liability of some entity other than the central bank.

TMF,

"I believe that Nick specified red notes as red currency, meaning liability of the central bank. We are saying red notes as green bonds, meaning liability of some entity other than the central bank."

I was thinking that red notes would also be a liability of the current owner. While true that the central bank would redeem red notes on par with other red notes (hence red notes are a liability of the central bank), the owner of any red notes would be balance sheet restricted in some way to keep a person from accumulating too many red notes in relation to the green notes and other assets that he / she possesses.

"The problem with sending red notes/green bonds back to the taxpayers is debt defaults."

Private debt defaults occur because most debt is fixed term to match our fixed lifetimes and because debt is typically not inherited by future generations. Once a person dies / company goes bankrupt, his / her / it's debt is not passed onto heirs or redistributed through the economy. And so, we (as private borrowers) pay back principle and interest over a fixed time frame based upon some form of amortization schedule.

But what if all debt was perpetual in the sense that only the government / central bank could retire it by combining red note / green note pairs received as taxes? Any time a person with debt passes away or a company goes bankrupt, his / her / it's debts are not dissolved but rather redistributed through an economy either through direct inheritance or government receivership and dispersal.

Nick postulates having the commercial banking sector regulate the total liquidity (green notes + red notes) while having the central bank regulate the net positive (green notes - red notes). What if instead with perpetual green and red notes we allow the commercial banking sector to regulate the additions to total liquidity (new green and red note pairs are created with each new loan), we allow the consolidated central bank / government to regulate subtractions to total liquidity (by recombining green and red note pairs received as taxes), and we let individuals decide what mix of green and red notes to maintain up to a "leverage" limit?

"I was thinking that red notes would also be a liability of the current owner."

I believe that is going to violate some accounting principles (liability of the central bank and liability of the current owner). I believe there is a "chain of debt" there.

"While true that the central bank would redeem red notes on par with other red notes (hence red notes are a liability of the central bank)"

I don't see that making red notes/green bonds liabilities of the central bank.

"Nick postulates having the commercial banking sector regulate the total liquidity (green notes + red notes) while having the central bank regulate the net positive (green notes - red notes)."

I don't get that at all. To see what is really going on, I believe the model needs to have "boxes" for both assets and liabilities so there are "green notes" and "green bonds" with no "red notes".

"Any time a person with debt passes away or a company goes bankrupt, his / her / it's debts are not dissolved but rather redistributed through an economy either through direct inheritance or government receivership and dispersal."

No thanks! I don't want somebody else's debt forced on me. Let the lender take the loss.

TMF,

I was thinking that red notes would also be a liability of the current owner. - I believe that is going to violate some accounting principles (liability of the central bank and liability of the current owner). I believe there is a "chain of debt" there.

Not really. If all red notes are the same (single interest rate, only retired by combined central bank / government effort), then it doesn't really matter who created the debt in the first place. Either green money flows from buyer of good to seller of good OR green bonds (red money) flows from seller of good to buyer of good.

While true that the central bank would redeem red notes on par with other red notes (hence red notes are a liability of the central bank) - I don't see that making red notes/green bonds liabilities of the central bank.

They would be liabilities of the central bank only in that one red note (green bond) always trades at par with every other red note (green bond).

Nick postulates having the commercial banking sector regulate the total liquidity (green notes + red notes) while having the central bank regulate the net positive (green notes - red notes). - I don't get that at all. To see what is really going on, I believe the model needs to have boxes for both assets and liabilities so there are green notes and green bonds with no red notes.

Okay, so we have green notes as assets and green bonds as quasi-assets. Green bonds are a liability in the sense that they must be maintained by owner (but only retired by government / central bank). Green bonds are an asset in the sense that they can be used in an exchange for goods (seller of goods gives green bonds and goods to buyer of goods) and are accepted by government in payment of taxes.

Any time a person with debt passes away or a company goes bankrupt, his / her / it's debts are not dissolved but rather redistributed through an economy either through direct inheritance or government receivership and dispersal. - No thanks! I don't want somebody else's debt forced on me. Let the lender take the loss.

If you are a taxpayer, then someone else's debt (the federal government's) is already "forced" upon you. If you are not a taxpayer, then I suppose you would feel no responsibility toward lenders to your government.

TMF: the costs of the bankruptcy of a bank debtor are shifter to shareholders, depositors, employees and so on. Classic pass-through analysis.

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