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Federal Treasury finances: a functional perspective

January 15, 2017

Modern monetary theory (MMT) offers an analysis of the flow of money within our economy, and in undertaking this task it proceeds from some basic assumptions, including the propositions that bank credit money and banking reserves are (a) destroyed when federal taxes are paid and when Federal Treasury securities are issued to the non-government sector, and (b) created when the Federal Government spends into the non-government sector. This article examines what the analysis implies within an Australian context, although the ideas and conclusions are more generally applicable. However we must firstly define what is meant by money.

  1. What is money?

Most economic textbooks tell us that money is any entity which (a) is accepted and used by the public as a means of payment for taxes and debts and for purchasing goods and services — in other words it behaves as a medium of exchange; (b) can be used as a store of value; and (c) possesses a unit of account (which in Australia is called the Aus Dollar). There is also an implication that the range of monetary transactions occurring and permitted within the real economy will embrace an adequately sized marketplace of players.

There exist three widely recognised forms of money:

(a) Currency, by which we mean coins and banknotes.

(b) Bank credit money, an intangible form of money created by commercial banks in the accounts of their retail depositors.

(c) Banking reserves (exchange settlement funds), created in the depository accounts of commercial banks with the Central Bank (CB).

Items (a) and (c) are collectively sometimes referred to as the monetary base. The “money supply” –  meaning money accessible and used by the nonbank sector – can be defined in various ways, the simplest definition (called narrow money) being the conjunction of bank credit money and currency in the hands of the nonbank sector.

  1. The Federal Treasury is not a bank

A number of economic commentators have suggested that the Federal Treasury behaves like a bank. In my opinion such a viewpoint is wrong, for the following reasons:

(a) Treasury does not take deposits from the public, or from the commercial banks.

(b) Treasury does not directly create credit money in the accounts of nonbanks (i.e. by contrast with commercial banks). When Treasury spends, it instructs the Central Bank to transfer reserves to the payee’s bank, which authorises that bank to create new credit money in the payee’s account.

(c) Unlike commercial banks, Treasury’s primary role is not the creation of financial assets via retail lending or the acquisition of commercial profit.

(d) Treasury does not lend reserves to commercial banks (i.e. by contrast with the latter, which often lend reserves to each other).

  1. Are Federal Treasury’s CB credits a form of money?

Given that the Federal Treasury is not a bank, the credits in its account with the Central Bank cannot be banking reserves (unlike those of commercial banks). And clearly these credits do not consist of bank credit money, which can only exist within the depository accounts that commercial banks make available to citizens and businesses. Neither is it currency, because it has no tangible form.  So the question arises, are these Treasury credits a form of money in any sense at all? Officially, they are not a form of money for the simple reason that they are excluded from the monetary base and also from every measure of the money supply.

The following propositions relate to this question.

  1. A monetarily sovereign entity, i.e. one which has the power to create and destroy money, has no use for that money — and in particular does not need to store it.
  2. If the Federal Government Treasury is not a bank, then its “deposits” in the Central Bank necessarily have a different status to the deposits of commercial banks in the central bank.
  3. One of the essential requirements of any entity entitled to be called money is that it is used by (traded, loaned/borrowed between) a sufficiently large number of marketplace players who have similar status and objectives in regard to those operations.  Bank deposits in the Central Bank satisfy this criterion, since all of the players are in competition with each other with the common objective of maximising their financial profit.  In contrast, the Federal Government maintains an account with its Central Bank for a quite different purpose, and its spending has a different objective.
  4. These days Federal Australian Treasury bond sales do match net spending (deficit spending), and so appear to top up the notional Treasury balance at Australia’s Central Bank – the Reserve Bank of Australia (RBA). However this is a relatively new development, having been introduced in Australia under the guise of ‘sound financial policy’ in 1982, and is not the practice in some comparable economies, such as Canada. Thus the Australian Treasury has not, since 1982, borrowed directly from the RBA – by selling bonds directly to the RBA or by using any other accounting mechanism (sometimes described as Overt Monetary Financing). Prior to 1982, it did sell bonds directly to the RBA, which meant – to take the logic to its obvious limit – that any number appearing within the government account at the RBA was rendered functionally meaningless.  The post-1982 voluntary constraint on government-RBA relations does not in any sense undermine monetary sovereignty, but it does appear to do so – by obscuring the fact that the Australian Government cannot ever become insolvent in its own currency, and is not limited by its ability to attract ‘money’ into its account at the RBA.
  1. The situation in the United States is a little different, in that the constraint on direct borrowing by the Federal Treasury is not voluntary, but is enforced by legislation. However even in this case the constraint may be easily bypassed if there happens to be a need to do so. Within Australia and the U.S. there exist statutory regulations to the effect that, whenever a difference over policy exists between Treasury and CB which cannot be resolved by negotiation, the will of Federal Treasury will ultimately prevail. So even if there happened to be a legislative constraint on direct borrowing, the Treasury could – if it so wished – issue a quantity of new bonds to the private sector and arrange for the CB to buy the same quantity of bonds from the private sector. The net result is obviously the equivalent of direct borrowing.
  1. The economic mainstream hold that the Federal Government’s “deposits” in its Central Bank account are a form of state fiat money, moreover one which is interchangeable with reserves. However the above propositions imply that such “deposits” are not money in any real sense of the word, but are merely accumulated credits in an operating account.  An operating account records a financial reality, but this does not imply that it is a form of money in a functional sense.

On this basis it may be held that the central government stands alone – that is, not in competition with any other entities possessing accounts with the central bank, and that the entries in the Government’s RBA account do not function as money.

John Hermann


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  1. Hi John
    Thanks for the “functional” item recently. i will need to read it a time or 2 to get my head properly around it. it is a great work you are doing

    1 Thanks also for the chart which i was pointed to back about 2005 showing in excess of 90% privately created credit money. it provoked my research since then with some achievement:
    a) the response i got from the UK Treasury FSR team to my idea of immediately bringing in a rule diverting Base Rate (cash rate) to the public purse – they did not deny the possibility, referring to office of fair trading (OFT) as needing to be involved – now part of the role of the Bank of England.
    my guess is that would take about half into the public purse and be practical if 4% cash rate, allowing 2% mark-up on top to commercials.

    Then b) Mervyn King (now Lord) saying in 2007 after i emailed him about 30 times property “growth” in 30 years
    that the finance sector has “un-level playing field” existing in its favour.

    2. QUESTION: Positive money has good defence of reasonable interest rates – obvious of course – and also a 2012 video of Mr King saying most of the money is created via these “loans” i.e. finance facility. He mentions cancellation of money at the end of the loans period, as others have done. Could you think on this? Clearly once in circulation (as in the case of property purchase/sale) money cannot be clawed back and cancelled, it is just the account figure that is cancelled at the bank. inflation makes the velocity higher and the value of each dollar less. Hence my estimate of the fairness of about half of a greater proportion as base rate – UK’s will have to come up. It is disgusting that UK are getting away with paying peanuts to savers and I can see no reason for it?
    CAN YOU VERIFY THIS, perhaps explain slowly and carefully if not true? “Clearly once in circulation (as in the case of property purchase/sale) privately issued money cannot be clawed back and cancelled, it is just the account figure that is cancelled at the bank.”
    Best regards and STEERglobal Group for Sustainability in _ _ _ _

  2. John Hermann permalink

    We have a dual monetary system, in which banking reserves tag along with bank credit money whenever borrowing/lending, and buying/selling transactions occur within the real economy. However when a payment is made by a non-bank to a commercial bank for any reason whatsoever, the bank credit money involved is fully cancelled from the money supply – while at the same time the banking reserves remain unchanged, merely transferring from one bank to another bank. Being the creators and destroyers of bank credit money, commercial banks have no need or use for this intangible form of money and do not store it.

    • thank you for addressing this, perhaps an example using figures?
      just taking the example of a real estate transaction, perhaps might be clearest. …

      can we start with, say £100k facility with 10k deposit (as it used to be, or £20k as now with some UK banks ) – for an apartment valued at 110k?.

      or Could be a £60 k commercial facility with £40k extra surety on property valued at £100k… What Happens, apart from the mortgage payments of interest and eventually principal sum kicking in big-time on a 20 year term after 10 years? i will try to scan a diagram-document for you..

      how would it work with your example text above translated into figures?

      regards, ian

  3. maybe i was hasty with the prev post – First, is there anything you can see wrong with the Question?

    Secondly, I should have said “UK Base Rate will have to come up” [ from 0.25/0.5% to nearer the AUS of 4% approx..

    best regards
    ian G

  4. Finally, for the moment – sorry for not sending the promised chart yet – can i correct punctuation in what we put above: should be “Then b) Mervyn King (now Lord) saying in 2007 (after i emailed him) there was about 30 times property “growth” in 30 years in some places in UK.. an average of 1800% over the nation.

    That statistic makes a mockery of Treasury/central bank inflation targets of 2% or 3% max, [This is relevant to the whole world because of the large amount of money created there and USA.] Compounding to 245% at 3% but actually some prices were at 30 times = 3000% over such a period! Creating unfairness to savers compared with property owners and contributing to divides. Therefore some correction of fundamentals needed. such as the diversion of base/cash rate interest to public purse,as i recommended.

    since then i have begun to suggest that a preferential rate could be offered for “Ecologically Fit” investments to a certain standard. For example double-insulated walls and roofs, thermal mass and natural air-conditioning to begin to minimise carbon usage (useful in Melbourne, etc) .
    the discount rate could be Green-Deal-like – interest equivalent to savings on the bills

    so the reserve bank could make available funds per customer to commercial banks at 0.5% up to $40k on the proviso that as fixed-rate finance over 20 years those customers pay at a total of 1.5% = $600.00 p.a. -= roughly equivalent to the expected bill savings. does this make sense?

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