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Why borrow when you can print?



November 08, 2009 – Comments (12)

For a few weeks now I've been wondering at the miraculous ability of Tim Geithner to run a huge budget deficit without increasing the govt debt. I even had this discussion with player lquadland10, pointing out how the debt clock numbers seem to grow for a week or so, only to be reset back to their previous readings by next Monday.  So in that Sep 28 post I speculated that some stealthy monetization program was under way.

Well, yesterday I saw some interesting links, and as a result I think I now have a better understanding of how that was possible. To make a long story short, it WAS a monetization program run by the Treasury and the Fed in tandem, but was run in a very roundabout sort of way that even now doesn't look entirely clear to me. Anyway, let's take a brief tour of the debt statistics.

First things first. My natural suspicion that the debt clock could just be wrong was not borne out by facts. The Treasury department's web site shows that the clock's behavior was not an aberration and that public debt actually DECREASED in October from 11.92 trillion to 11.89 trillion. This was all the more inexplicable that all web resources agreed there was no way the budget could be running a surplus at this point in time. So the missing funds must have come from somewhere, the only only question is the source of these funds.

Could it be that the Treasury just tapped its international reserves? No, the facts refute this assumption. According to the Treasury's press room, at the end of September the reserves stood at 134 billion; they were essentially unchanged by the end of October. Moreover, in January 2009 these reserves stood only at 76 billion. It turns out that during this year of record-breaking deficits the government actually increased its international holdings by some 50 billion!

So where did the money come from? The answer is, from the difference between government borrowing and budget deficit. Let us see how the numbers work.

The CBO now estimates that the deficit over the whole 2009 financial year was 1.4 trillion.  The same Treasury department's web site that I mentioned above shows that public debt increased from 10.1 trillion to 11.9 trillion during that year. So an increase of 1.8 trillion! It appears the government had borrowed from the public some 400 billion more than it actually needed. In fact, if we include the numbers from 2008, we'll see another trillion borrowed in that year - against the deficit of 460 billion. The extra half-trillion dollars is mostly due to September borrowing - remember that unforgettable month when Paulson was crawling on his knees begging the Congress for spare change to save Goldman Sachs?  So overall borrowing by the Treasury since the start of the so-called "crisis" exceeded the actual deficit to the tune of 900 billion.

So the debt clock puzzle is really no puzzle at all. The Treasury is able to reduce its debt outstanding while still running a deficit by making use of the extra funds it had borrowed several months ago. The only question is, what was the reason for borrowing these extra 900 billion.

The answer that I now believe to be correct is the Treasury's Supplementary Financing Program launched in September 2008. defines this program thus: "SFP. Program enacted by the Treasury Department to provide supplementary funding to the Federal Reserve to offset the financial strain due to the creation of various liquidity programs and facilities during the financial crisis of 2008". The Treasury's own press release from Sep 17, 2008 elaborates as follows:

"Washington- The Federal Reserve has announced a series of lending and liquidity initiatives during the past several quarters intended to address heightened liquidity pressures in the financial market, including enhancing its liquidity facilities this week.  To manage the balance sheet impact of these efforts, the Federal Reserve has taken a number of actions, including redeeming and selling securities from the System Open Market Account portfolio.

The Treasury Department announced today the initiation of a temporary Supplementary Financing Program at the request of the Federal Reserve.  The program will consist of a series of Treasury bills, apart from Treasury's current borrowing program, which will provide cash for use in the Federal Reserve initiatives."

What does the term "System Open Market Account portfolio" actually mean?  Let's look up the definition. Investopedia defines SOMA as follows:

"An account that is managed by the Federal Reserve Bank, containing assets acquired through operations in the open market. The assets in the System Open Market Account (SOMA) serve as a management tool for the Federal Reserve's assets, a store of liquidity to be used in an emergency event where the need for liquidity arises, and as collateral for the liabilities on the Federal Reserve's balance sheet such as U.S. dollars in circulation. The SOMA consists of the domestic securities and foreign currency portfolios of the Federal Reserve. The domestic portion consists of U.S. dollar-denominated treasuries, while the foreign currency portion consists of different investments all denominated in Euro and Yen currencies".

So, to translate it from official-speak into plain English, Bernanke decided he wanted some cash to save the better-connected bankers from the fallout of the crisis. To that end, he sold some of his treasuries. But since the bankers had no cash to buy treasuries with (and since the whole point was to provide cash to the bankers, rather than withdraw cash from the system), that left him with just one buyer - Hank Paulson from the Treasury Department. So Paulson crawled on his knees for a few minutes, got the approval from Congress, borrowed several hundred extra billions from the public, and used them to buy/redeem Bernanke's treasuries.

Does the size of SFP match the 900 billion gap? Yes, it roughly matches it. Look at these numbers, for instance:

"In September 2008, the Treasury and the Fed announced a new and temporary Treasury Supplemental Financing (SFP) account to aid in the Fed's quickly expanding liquidity facilities by sterilizing some of the flows. Since then, one must look closely to see the story developments around the SFP. In November 2008, the Treasury announced that it would be unwinding the SFP account "in coming weeks". In February 2009, the Treasury announced that it expected to borrow $165 billion of marketable debt for the April-June 2009 quarter. This did not include funds to replenish the SFP account, as the program was deemed temporary. In April 2009, the Treasury announced that its April-June 2009 actual borrowing was $196 billion greater than its February estimate of $165 billion, due in part to the unannounced continuation of the SFP account. In April 2009 (same statement as above), the Treasury announced an expected $515 billion in borrowing for the July-September 2009 quarter, with an explicit $200 billion borrowing to fund the SFP account." 

However, the question then arises: who was that "public" that lent those extra 900 billion to Hank Paulson (in other words, that bought an extra 900 billion worth of treasuries from Hank Paulson?). Recall the premise: banks are broke, they need that cash themselves in order to pay their debts. The Chinese did buy some of the treasury junk, but surely not in such quantities. So the snake now bites its own tail: in his attempts to raise the cash by issuing treasuries, Hank Merritt Paulson, Jr. could find only one reliable buyer: Ben Shalom Bernake. In Q2 of 2009 alone, the Fed accounted for 50% of all treasuries purchases. When all is said and done, the essence of the SFP program is that Bernanke is buying treasuries from Bernanke.

But did we say that Bernanke is selling the treasuries in order to raise some cash to give it to his favorite bankers? If so, then how does he get the free cash with which to buy those same treasuries?  Could it be from the printing press?

In a classical story, the two Officials on an uninhabited isle were trying to fight hunger by debating how "one's own juices generate other juices, and these in their turn still other juices, and so it goes on until finally all the juices are consumed." "And then what happens?" - a hungry Official asked then, and his comrade replied: "Then food has to be taken into the system again." 

After reshuffling the deficit from Bernanke to Paulson and then to Bernanke again, we are back to where we started from: the extra money has to be printed. In the final analysis, the Fed's balance sheet is the ultimate source of the liquidity that was handed over to bankers. 

So what is the purpose of this little mystification? And why did Bernanke have to raise his cash-for-bankers is this roundabout way instead of just printing it right there and then? The answer is, it was Bernanke's way of fighting inflation. The following article gives a more or less satisfactory explanation of his logic (even though the specifics still escape me - maybe I'll understand it all one day, but for now I only get a vague general idea):

"As we wrote two days ago, Treasury is effectively winding down its Supplemental Financing Program, the stated intention of which on its inception in September 2008 was to, “drain reserves from the banking system, and therefore offset the reserve impact of recent Federal Reserve lending and liquidity initiatives.”  Delving into the mechanics of it, here is what happened:

Treasury announced special auctions for cash management bills, the proceeds of which were placed on deposit with the Federal Reserve in a special account (as opposed to the proceeds being kept by Treasury to fund the government).  This allowed the Federal Reserve to use these funds (which topped out at $558.9 Billion in November 2008) to borrow or buy securities primarily from banks and broker dealers to help “unfreeze the credit markets.”  The Fed could have simply borrowed or bought securities with money it printed, but this would have expanded its balance sheet by creating excess reserves in the accounts that banks are required to keep with the Fed.  These reserves can be multiplied by at least ten times and used by banks for lending.  At the time, the Fed was rightfully concerned about inflation becoming unmanageable once the credit markets thawed, and about being able to keep the Fed overnight lending rate (fed funds target rate) above zero.  Accordingly, Treasury’s SFP helped to keep the Fed balance sheet under control (if you can call a multiple hundred percentage increase “under control”).  The amount of money that flowed into the financial markets from the SFP was the same as it would have been had the Fed printed the money; however, SFP money could not be multiplied by banks.

Congress granted the authority to the Fed to pay interest on excess reserves held by banks on deposit with it as of October 1, 2008.  This new tool obviated the need for the SFP as the Fed could now simply incentivize banks to not lend against their excess reserves (by paying them interest to keep their reserves at the Fed).  Accordingly, in November 2008, Treasury announced it would reduce the SFP, and it has held steadily at $200 Billion for most of 2009."

So the point was for Bernanke NOT to print money - at this point in spacetime. He had printed it at other moments as part of other bailout programs, and like any good restaurant owner, he didn't want customers to watch the food being prepared. In this particular program, he wanted to act like a Paul Volcker type - to showcase his austerity and commitment to low inflation, while hyperinflation was being cooked in a separate room.

But then Bernanke got a new tool from the Congress and soon lost interest in this Potemkin village. He could now print money to his heart's content and tell the markets that he'd sterilize it later on. So there was no longer any need to borrow cash from Paulson's successor Geithner. The program was reduced, and the Treasury department was able to take some of that extra cash back from the Fed and use it to retire some of its extra debt to the public, which, as we remember, is just another name for the Fed. No wonder the public debt stopped growing and even went down a little. 

So what's the moral of the story? As we expected, it was partial monetization of the public debt that was responsible for the recent stable readings of the debt clock. But that clock had been running too fast during the last year so that several hundred billion dollars which had really been earmarked for monetization were mistakenly registered as part of the public debt due to a technicality. This technicality is now being taken care of. Eventually, the official budget deficit numbers should serve as a good proxy for the growth of public debt. As a result, we won't be going past the 12.1 trillion cap anytime soon, contrary to what some people expect. Of course, the absence of free lunch means that we'll pay the price for having a low deficit (to the extent that the adjective "low" is applicable to a number like 12.1 trillion), but we'll pay it later - whether in the form of inflation if liquidity is not removed soon, or in the form of recession if it does get removed. Meanwhile, I will have a good chance to win a Caps penny on Nov 30.




12 Comments – Post Your Own

#1) On November 08, 2009 at 5:13 AM, whereaminow (< 20) wrote:

Great post zloj.

Off subject curiousity, what line of work are you in? You don't have to answer (obviously, how could I possibly compel you!). Just wondering.

David in Qatar

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#2) On November 08, 2009 at 6:06 AM, memoandstitch (< 20) wrote:

I think the short version is to look up Quantitative Easing here.  All those programs are mechanical parts.  The concept is there for some time.

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#3) On November 08, 2009 at 7:31 AM, whereaminow (< 20) wrote:


Everybody here is familiar with the concept of QE. Can you explain how the structure of production is affected by the artificial lowering of interest rates?

David in Qatar

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#4) On November 08, 2009 at 2:35 PM, ReadEmAnWeep (87.67) wrote:

If we print enough and cause enough inflation - that huge deficit we have now will seem like nothing. Maybe that is there plan :P

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#5) On November 08, 2009 at 4:24 PM, XXX222 (< 20) wrote:


I noticed the same thing you did with the deficit clock seemingly being reset every so often but I never did any follow up on it. Good work explaining what's going on.

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#6) On November 08, 2009 at 9:03 PM, jatt22 (59.79) wrote:

great  blog .  thanks for sharing  + rec

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#7) On November 08, 2009 at 9:49 PM, memoandstitch (< 20) wrote:


I don't understand your question.  Structure of production of what?  QE also is not quite related to artificially low interest rate beyond the correlation that it is usually employed when interest rate can no longer be lowered.

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#8) On November 08, 2009 at 10:38 PM, whereaminow (< 20) wrote:


Exactly, I'm asking you a question that you've never considered.

If QE is employed, the amount of money available is increased. That's not a fancy speculation. That's the purpose of QE.

If the pool of money is increased, the cost of borrowing it is decreased. Simple supply and demand. The rate of interest lowers.

I'm asking you, how is the structure of production affected by this artificial (government or central bank imposed, rather than market imposed) low interest rate?

David in Qatar

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#9) On November 08, 2009 at 11:20 PM, memoandstitch (< 20) wrote:

I can't tell whether I have thought about your question or not because it's an incomplete question.  You haven't answered me: the structure of production of what?  money?  cars?  candies?

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#10) On November 08, 2009 at 11:23 PM, whereaminow (< 20) wrote:


Fair response and a good one. It wasn't a complete question. Are you familiar with the diffeence between higher order goods and lower order goods? I'm speaking of the impact on the production of higher vs. lower order.

David in Qatar

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#11) On November 10, 2009 at 2:10 AM, memoandstitch (< 20) wrote:


I don't see much change in the production of non-financial goods because people don't expect low interest rate to exist forever.  However, if interest rate stays low for 3+ years, we would be in uncharted territory as you have to worry about inflation and dollar-devaluation.  High-order-vs-low-order doesn't seem to be a good dividing line for me.

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#12) On November 12, 2009 at 10:25 PM, whereaminow (< 20) wrote:


It's been awhile since I checked this post. (Should have marked it for following). And zloj I apologize for highjacking it, feel free to hijack mine any time you please :)

The difference is time. It's something called Capital Theory. Unfortunately, most economic schools don't have a Capital Theory, much to their detriment.

See this article for an explanation.

To simplify, let's say you have a choice between opening a diner and opening a oil refinery. Which of these two will return immediate products (a sandwich eaten at lunch, versus the various thousands of products that use refined oil.)

One of these factors of production requires real savings among consumers and one doesn't. That is because in order for the oil refinery to be profitable, there must be future demand as opposed to the present demand of your diner. I'll let you stew on that. Consider the implication that interest rates play in these decisions.

Food for thought :)

David in Qatar

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