Hey, Janet, How’s That Interest Rate Increase Working Out?

I finally understand the thinking behind the Fed’s activities trying to raise interest rates.  Prof. Ray Fair (Yale) was kind enough to explain this in words of one syllable.  The Fed believes that raising interest rates paid on reserves will induce banks to sell Treasury securities so they will have more reserves.  Treasury security prices fall, interest rates rise, voila.

Utter nonsense.  I once respected the Fed’s economists.  No more.  Here’s why.

The Fed is assuming the banks will sell Treasury securities.  Why?  There are many other assets banks can sell if they want to increase their reserve deposits.  In principle, those asset sales should push up interest rates.  While I could draw a link between CDO prices and market interest rates, that seems kind of pointless.

But the real problem is that the Fed has not understood why banks are holding all those reserves.  There are two reasons.  First, there is incredible risk aversion caused by the random, frequent regulations and lawsuits emanating from the Obama administration.  Second, there is the small matter of loan demand.  Banks are holding reserves because they don’t see demand for loans whose return is worth the risk.  The only way loan demand will increase is for the economy to ascend to a decent growth rate.  Until that happens, the Fed should just give up.

For those looking for evidence, I offer the Treasury yield curve between December 17, 2015 and January 14, 2016.  Sure doesn’t look like interest rates are rising.

Treasury Yield Curves

Let’s See If The Fed Can Make It Stick

The Board Of Governors The Forever ZIRP

The Board Of Governors: Chair Janet Yellen, Vice-Chairman Stanley Fischer, Jerome H. Powell, Daniel K. Tarullo, Lael Brainard

The Fed has spoken.  The new target rate for the Federal Funds rate will gradually rise to between 0.25 and 0.50 percent.  I wrote extensively about this yesterday.  It will be interesting to see whether the folks at the Board of Governors can make this rate increase stick.

I Was Wrong About ZIRP

Slim Pickens' finest cinematic moment i was wrong about zirp

Slim Pickens’ finest cinematic moment (click for larger image)

A few months ago, I argued that the Fed’s zero-interest-rate policy (ZIRP) would last forever.  Today I admit I was wrong about ZIRP.

Although negative rates have a “Dr. Strangelove” feel, pushing rates into negative territory works in many ways just like a regular decline in interest rates that we’re all used to, said Miles Kimball, an economics professor at the University of Michigan and an advocate of negative rates.

Not, mind you, because the Fed will raise interest rates any time soon.  No, the geniuses at the Federal Open Market Committee and the Board of Governors seem to be leaning in a different direction: NIRP.

Better get used to seeing those initials.  They stand for negative-interest-rate policy.  That’s right.  The Fed thinks they can drive nominal short-term interest rates below zero.

For a good discussion of the Fed’s likely direction and its implications, see Greg Robb’s piece on Marketwatch.com. Greg gets it right here →→→→→→→→→→→→→→→→→→↑

We’ve Seen Negative Yields Before

Now it happens that there is a Treasury security that has paid negative interest rates off and on over the last couple of years: TIPS.  That’s Treasury inflation-protected securities.  These securities pay a real interest rate.  So when their yield is negative it simply means markets expect future inflation to be higher than current nominal interest rates.  (Remember the Fisher equation: r = i pe where r is the real rate of return on a security, i is the nominal return as usually quoted, and pe is expected future inflation over the life of the security.)

But negative nominal yields are a different kettle of fish.  Positive nominal yields mean borrowers are paying lenders to lend them money.  Negative nominal yields mean lenders are being asked to pay borrowers for the privilege of lending them money.  Most of the time that is insane.

Would NIRP Work? No.

And it would not make any difference.  The Fed has been flooding markets with liquidity for five years.  Virtually the entire tsunami has ended up being held as bank excess reserves at the Fed.  Why will more liquidity lead to a different result?  As I’ve argued in the past, monetary policy has done all it can to solve this crisisThings will not improve until (if?) a new president takes office and begins to undo some of the regulatory mayhem that the current administration has wreaked on the U.S. economy.

My guess is that the Fed thinks they can do this because there has been a global flight to safety.  And safety is still good old U.S. government Treasury securities.  Whether global markets want safety so much that they are willing to pay a premium to get it remains to be seen.  I, for one, am skeptical.  New Zealand, Australia, South Africa, Chile, the U.K., Norway, and Canada all have pretty safe government securities.  I predict the Fed will soon discover another result of globalization.


I learned a lot of what I write when I took monetary theory in graduate school. Prof. Karen Johnson (later my dissertation adviser), fresh out of M.I.T., inspired much of my thinking.  (I hardly have to add that Dr. Johnson is in no way responsible for my ramblings here.)  She understood both the theory (complete with heavy-duty math) and the practical aspects of monetary policy.  Sadly, I fear that institutional knowledge that I took for granted has been lost.

The Forever ZIRP

ZIRP is the acronym for zero-interest rate policy, currently being followed by many central banks. For better or worse, the central bankers have backed themselves into a corner. My forecast is the forever ZIRP. Read on.


On June 4 the IMF urged the Fed to postpone raising interest rates until 2016. I’ll have more to say about that later in this article. The thrust of this article, however, is a forecast: The Fed’s Board of Governors has backed itself into a corner. They will be forced to keep interest rates at zero virtually forever. This also applies to other major central banks, including the European Central Bank whose gurus recently announced a negative interest rate policy. (Japan has a head start, having implemented ZIRP years before the Fed and ECB caught up.)

IMF Director-General Christine Lagarde The Forever ZIRP

IMF Director-General Christine Lagarde

Who Owns the Bank?

There’s an old saying among bankers: If you have a small loan the bank owns you. But if you have a really, really big loan, you own the bank. Apparently this no longer applies to your friendly local banker. Central banks are now owned by their biggest borrowers: national governments.

The Board Of Governors The Forever ZIRP

The Board Of Governors: Chair Janet Yellen, Vice-Chairman Stanley Fischer, Jerome H. Powell, Daniel K. Tarullo, Lael Brainard

Let’s look at the latest data for the U.S.[1] At the end of 2014 the gross federal government debt was $17.8 trillion. Net interest paid on this debt was $0.23 trillion. The implied interest rate was a whopping 1.29%.

Suppose the Fed raises interest rates by, say, 200 basis points. Assume that increase is passed through to the interest rate paid by the government.[2] The interest rate will be 3.29%. And interest payments on the government debt will become $0.58 trillion.

“So what?” you ask. To put this in perspective the total government budget deficit in 2014 was $0.48 trillion. In other words, a two percentage point increase in the interest rate would double the federal government budget deficit.

And now we can see the real danger of the persistent, large deficits the government has run under the Obama administration. That new debt does not vanish at the end of each year. It accumulates. Effectively, the federal government owns the Federal Reserve.

As always, my methods are transparent.  Click here to download the Excel workbook and play with your assumptions.

Why Did the IMF Caution the Fed?

The U.S. government is not alone. There are many other governments with government debt to GDP ratios over 100 percent. Each and every one of those governments is holding their central bank hostage. The lone exception is the ECB which does not technically have a single government to which it reports. Until recently, the ECB has shown little sympathy to the plights of Greece, Spain, Italy, and Portugal. But a negative interest rate policy is a subsidy to every government that is part of the eurozone. The IMF is simply trying to postpone the inevitable.


Decades ago I was privileged to learn monetary theory from Dr. Karen Johnson. She warned us of the dangers of running federal government budget deficits when the economy was reasonably healthy. Her main concern was what the government would do if the deficit was already large and the economy slipped into recession. Even with her intelligence, I doubt she forecasted how badly various governments have messed up their budgets.

[1] Economic Report of the President, 2015, Table B-22. Excel file can be downloaded from this link XLS. Accessed June 5, 2015.

[2] In practice, this will take some time due to the term structure of the U.S. government debt. T-bills will be affected almost immediately. But T-bonds will take quite a bit longer to be refinanced. As an economist, of course, I know this is irrelevant because the true cost of borrowing is the opportunity cost.

Monetary Policy is Like Pushing on a String

People seem to have forgotten this lesson. Central banks can only directly affect the quantity of bank reserves. That is the “push.” The money supply, however, only grows when banks lend those reserves. And that has been the source of the Fed’s problem since 2008.

The Fed has been buying securities at a furious rate. In 2013 our central bank bought around 70% of the net new issues of U.S. debt. And it has done almost no good. Banks are experiencing a quadruple whammy:

  1. The 2008 mortgage meltdown has made them more risk-averse,
  2. A hostile administration in Washington, D.C., seems ready to levy fines and file lawsuits whenever the U.S. Treasury needs funds,
  3. Huge regulatory uncertainty about how the Dodd-Frank Act will be implemented, and
  4. A fundamental lack of loan demand from their usual market: small businesses.

And they are not lending. They are sitting on huge piles of excess reserves.

Excess Reserves as a Percentage of Total Reserves

But what about the money supply? Here’s the unhappy picture:

Growth of M1, M2, and Reserves

Average annual growth rates of M1 and M2 are in the 6% – 8% range. Reserves have averaged 215.25% per year. Reserves are not being loaned. And until lending picks up the Fed might as well close up shop.

As always, my methods are transparent. Click here to download the usual Excel workbook.


While I don’t ordinarily use Wikipedia, the site can be helpful when trying to track down the origin of a phrase. (Footnotes are also copied from that source.) Forthwith,

According to Roger G. Sandilans[1] and John Harold Wood[2] the phrase was introduced by Congressman T. Alan Goldsborough in 1935, supporting Federal Reserve chairman Marriner Eccles in Congressional hearings on the Banking Act of 1935:

Governor Eccles: Under present circumstances, there is very little, if any, that can be done.

Congressman Goldsborough: You mean you cannot push on a string.

Governor Eccles: That is a very good way to put it, one cannot push on a string. We are in the depths of a depression and… beyond creating an easy money situation through reduction of discount rates, there is very little, if anything, that the reserve organization can do to bring about recovery.[3]

The phrase is, however, often attributed to John Maynard Keynes: “As Keynes pointed out, it’s like pushing on a string…”, “This is what Keynes meant by the phrase ‘Pushing on a string.'”[4]


Loan demand will not pick up until after the 2016 election at the earliest.  Until then, we’ll just have to try to hang on.

[1] Sandilans, Roger G. (2001), “The New Deal and ‘domesticated’ Keynesianism in America, in John Kenneth Galbraith and Michael Keaney (2001). Economist with a Public Purpose: Essays in Honour of John Kenneth Galbraith. Routledge. ISBN 978-0-415-21292-2., p. 231

[2] John Harold Wood (2006). A History of Central Banking in Great Britain and the United States. Cambridge University Press. ISBN 978-0-521-85013-1., p. 231; it cites U. S. Congress House Banking Currency Committee, Hearings, Hearings, Banking Act of 1935, March 18, 1935, p. 377.

[3] Ibid.,

[4] Joseph Stiglitz (April 8, 2008). “A deficit of leadership”. The Guardian (London). Archived from the original on May 13, 2008. Retrieved April 27, 2008.

The Curious Case of the Missing 105 Billion Dollars

The Fed's Custody Account (source: Zerohedge)

The Fed’s Custody Account (source: Zerohedge)

Over the past week, a controversy has developed about whether or not there was a $105 billion “withdrawal” from the Federal Reserve.  As of today, this has morphed into the curious case of the missing 105 billion dollars.  Included in this mystery are writers who apparently contradict numbers and graphs that are either included or linked from their own articles.  My original hypothesis was that the “withdrawal” was Russia pulling out assets ahead of the Crimea invasion.  I’ve changed my mind a couple of times since then.  But after reading today’s reports, I now firmly believe that $105 billion outflow was, in fact, caused by Russia.  And, as an added bonus, I am willing to speculate about where it ended up: Belgium. Read on for the details.

The Beginning

I first got wind of this from Zerohedge (Tyler Durden).  He posted two articles on March 14.  The first pointed to a $104.5 billion outflow from the Federal Reserve’s “custody account.”  The second focused on Russia’s role in this outflow.

The custody account is where the Fed holds U.S. government securities that are actually owned by foreign governments.  The Fed is holding these securities “in custody” for the government.  An outflow in excess of $100 billion is very unusual. During the past year, the second-largest drop in the custody account was $38 billion in July, 2013.  Mr. Durden’s (and my) best guess was that the Russians had pulled their holdings of U.S. securities out of the Fed before sanctions were imposed.  Presumably, those securities could have been frozen by sanctions.  Too late now!

Update March 20

Yahoo finance had this to say: “As the chart shows, custody holdings increased by $32.3 billion this week.”

There”s just one slight problem: the linked chart shows no such thing.  In fact, custody holdings fell by about $67.5 billion.  I’ll discuss that in more detail below when I discuss the Fed.  But we also have an article from Business Insider:

The big question is: will the Russian institutions sell large amounts of their holdings which could de-stabilize the market in the near term?” said Rjavinski and Rusinski. “To be exact, it is roughly a $139 billion dollar question, since that was the latest report amount of Treasuries held by Russian official institutions.”

To put Russia’s presence in the Treasury market into context, China holds $1.26 trillion worth of Treasury securities and Japan holds $1.18 trillion. According to Treasury data, Russia is only the eleventh largest overseas holder of Treasuries.

“Not only are they far cry from the two behemoths – China and Japan – but also place close to the bottom of the “peloton” in the Treasury buyer’s race,” added Rjavinski and Rusinski.

Basically, Russia isn’t really that big of a player in this market.

Oh, really?  As of December 31, 2013 Russia held $138 billion of U.S. government securities.  Data is from the U.S. Treasury Department and is available in my Excel workbook (click here).

Here’s the list of the eleven countries with the biggest holdings of U.S. securities.  You can subtract $105 billion from the total for Russia.



 % of










Carib Bnkng Ctrs





















Hong Kong






And then Business Insider continues,

In other words, the recent drop in custody holdings may be at least partially explained a continuation of a declining trend of custody holdings, which in turn is explained by emerging-market selling.

There’s only one problem: the graph that accompanies the above statement also contradicts it.  Note the sharp drop in March, 2014 — well below the downward trend the article cites.

Business Insider Graph

Business Insider Graph

What Does the Fed Say?

Every week, the Fed issues a release titled “Factors Affecting Reserve Balances.”  If you look at this report and become attached to it, my advice is to stop.  The Fed is a big, sprawling organization and their books reflect that.  Use your browser’s page search function (usually Ctrl-F in Windows or Command-F on the Mac) and search for “custody.” That should take you to 1A. Memorandum Items.  Between March 12 and March 19, 2014, the custodial account dropped by $67,746 million.  Remember, the actual withdrawals began the week before March 14, so the $67.5 billion is only part of the total.  (Again, this account for March 19 is included in the Excel workbook.  Click here. If you just want the custody data as a pdf file, click here.)

What’s That About Belgium?

Suddenly, Belgium has become the third-largest holder of U.S. securities.  Again, Zerohedge has the story.



Mr. Durden is cautious interpreting this data.  I have no such compunctions.  It looks to me like a chunk of that flight capital ended up in Brussels (or vicinity — Belgium isn’t all that big).  When the reports for February and March come out, I predict Belgium will move even higher.


The Russians did it.  Their holdings were large enough and the timing is too good to be a coincidence.  I realize I am committing a cum hoc ergo propter hoc fallacy.  Go find the data to convince me I’m wrong.

Inflation is Right Around the Corner

Commodity Inflation

Source: Wall Street Journal

[Edited March 19, 2014 to clarify the Fed’s role in all this.]

Inflation is right around the corner.  And that will pose a major challenge to the Federal Reserve.

Federal forecasters estimate retail food prices will rise as much as 3.5% this year, the biggest annual increase in three years, as drought in parts of the U.S. and other producing regions drives up prices for many agricultural goods. The Bureau of Labor Statistics on Tuesday reported that food prices gained 0.4% in February from the previous month, the biggest increase since September 2011, as prices rose for meat, poultry, fish, dairy and eggs.

The source of this inflation is rising food prices.  California’s central valley and Salinas valley produce much of the country’s fruits and vegetables.  The drought this year brings back memories of previous droughts in the 1970s and 1980s.  But this time more water is being diverted into the Sacramento delta to help save the delta smelt, an endangered species.  Central valley farmers will receive a water allocation of zero.  Many have already written off this crop year.

A Primer on Negative Supply Shocks

The Federal Reserve does not have the necessary tools to fight this kind of inflation.  Even today, fiscal and monetary policy can only affect aggregate demand.  Increasing food prices are a negative shock to aggregate supply. The short-run impact is a higher price level, higher unemployment, and slower economic growth. The most extreme example of this was the oil price shocks of the 1970s.  At that time we didn’t understand supply shocks.  We learned and improved our models.  But understanding does not mean policy tools have been developed to handle supply shocks.  In brief, the Fed has three choices when faces with a negative supply shock:

  1. They can raise interest rates to fight the inflation.  This will increase unemployment and slow economic growth.
  2. They can lower interest rates to fight unemployment.  This will lead to higher inflation.
  3. They can follow an intermediate path (including possibly not changing policy at all).

The Fed largely focuses on “core inflation” which ignores food and energy prices.  Therefore, they are most likely to not change policy.  But inflation is still inflation.  A higher inflation rate will be factored into nominal interest rates (at least short-term rates).  One way to hedge against unanticipated inflation is to shift your portfolio into Treasury Inflation Protected Securities.  Let’s take a quick look at how the yield curve and inflation expectations have shifted over the last few weeks.

Expected Inflation (5 year horizon)


Treasury Real Yield Curves


Taken together, these graphs tell an interesting story.  First, expected inflation over the next five years has actually fallen a bit in March.  (The calculation is the nominal interest rate minus the real interest rate for five year government securities.)  However, look at the way the TIPS yield curves have rotated around about a six year horizon.  Longer than that, the real interest rate has fallen fairly sharply, indicating rising prices.  Why would the demand for TIPS rise?  Fear of inflation — or, possibly, just fear in general.  But look at the five year yield.  That part of the curve rotated up, meaning demand fell for the five year TIPS.

Does this mean anything?  Are people really more worried about long-term inflation?  And did the markets get that much more worried in March?  In any case, this isn’t really relevant to short-term inflation.  But it is interesting. (As always, my methodology is transparent.  Click here to download an Excel workbook that contains the underlying data.  Data on the first sheet is drawn from the St. Louis Fed’s FRED plugin for Excel.)

Corn, Wheat, Soybeans, Oh My

A report in the March 18 Wall Street Journal predicts food prices will rise between 2.5% and 3.5% in 2014.  In January, 2014, non-food inflation (using the CPI) was 1.7%.  Assuming non-food inflation remains constant, the implied overall inflation rate is between 4.2% and 5.2% per year.  Better start planting that vegetable garden right now.

Wheat and soybeans are not much better according to a report out today (March 19).

Wheat futures for May delivery gained 16 cents, or 2.3%, to $7.08 1/2 bushel on the CBOT. The grain earlier reached $7.09 1/2 a bushel, the highest intraday price for a front-month contract since Oct. 23.

Soybeans rose to the highest intraday price in more than a week after a Brazilian industry group lowered its forecast for production in the South American country.

Chicago Board of Trade soybean futures for May delivery gained 14 1/4 cents, or 1%, to $14.32 1/2 a bushel. Futures earlier rose as high as $14.42 a bushel, the highest intraday price since March 10.

Can Imports Save the U.S.?

All of the anti-NAFTA propagandists better breathe a sigh of relief.  Higher U.S. prices will mean greater imports from Mexico.  Central and South America will also contribute.  But that will only dampen the inflation, not eliminate it. And Brazil, supplier of staples like coffee and sugar, is experiencing a drought of its own.

Futures prices for the arabica coffee variety are up 67% since the start of the year. Raw-sugar prices have risen 8%. Soybeans, which have been affected by drought in some areas and too much rain in others, also are up 8%.

Speaking as a coffee addict, I am disheartened to learn that the price of Arabica beans (the good stuff) rose 44% … in February!

The most actively traded contract, for May delivery of arabica coffee, soared 7.3% on Monday to $1.9345 a pound, a nearly two-year high, on ICE Futures U.S. March coffee jumped 7.1% to $1.9260 a pound, bringing year-to-date gains to 74%.

In February alone, worries about this year’s Brazilian supplies pushed the price of arabica futures up 44%, the biggest monthly percentage increase in almost two decades.

Can the Fed Do Anything?

I have to emphasize two things.  First, this is short-run inflation, meaning it is not being caused by an increase in the growth rate of the money supply.  Second, this is a negative supply shock, meaning there is very little the Fed can do about it without causing damage to the real economy.  Given that Dr. Yellen eliminated any mention of the unemployment rate from today’s Fed press conference, it’s a safe bet she doesn’t want to cause it to increase.  But if the Fed tightens monetary policy to fight supply inflation, higher unemployment and slower economic growth will be the inevitable result.


I have often wondered what Ben Bernanke thought as financial markets collapsed almost the minute he was sworn in as Fed chair.  Today, Janet Yellen is about to find herself in a similar position.  My advice: buy canned food now. And plant that vegetable garden.  Who knew Michelle Obama could forecast that well? (Remember, her first year as First Lady she planted a vegetable garden at the White House.)

Money, Income, and Wealth

Money, income, and wealth are three words familiar to everyone.  People often use them interchangeably.  But to economists these three words have very different meanings.  My goal is to explain what each means and how the three are related.


Money is anything that is widely accepted in exchange for goods and services in ordinary commercial transactions.  In other words, money is whatever you use to buy stuff.  Many people call paper bills and coins “money.”  Economists call those items currencyToday just under half of the U.S. money supply is currency.

A while back some otherwise sensible economists proposed having the U.S. Treasury Department mint a $1 trillion coin.  Getting into the spirit of this idea, I asked my Twitter friends to name the coin and (if possible) provide a design.  The winner was the Freddie Krugerrand:

The Freddie Krugerrand

The Freddie Krugerrand

[A note from my attorneys: the above coin is not legal currency anywhere as far as I know.  Attempts to copy and spend it will almost certainly get you in a lot of trouble.]

But you can buy stuff with things that are not currency.  Your personal check is one example.  If you use a debit card to transfer funds from your checking account to the sellers account, as far as the Federal Reserve is concerned that is identical to writing a check.  What counts is not the paper check or the piece of plastic that is the debit card.  What matters is the balance in your checking account.  For historical reasons, the Federal Reserve calls these balances checkable deposits.  Those balances are a little more than half the U.S. money supply.

Wait — the Federal Reserve?

Every developed country has a central bank that is in charge of managing the quantity of money in circulation.  In the U.S. the central bank is the Federal Reserve system. The U.S. currency is, of course, the dollar.  But beware — other countries use currencies called “dollars” that usually cannot be exchanged for U.S. dollars one-for-one.  For example, the exchange rate between the Canadian dollar (CAD) and the U.S. dollar (USD) on October 4, 2013 was 1.03213 CAD per USD.  In other words, it took 1.03213 Canadian dollars to buy one U.S. dollar. (I use Oanda.com to find exchange rate information.  Usual disclaimers apply.)

In Europe, a group of countries has decided to use a single currency, the euro. The European Central Bank controls the quantity of euros in circulation.

Back to Money

There is one other minor part of the U.S. money supply: travelers’ checks.  They make up less than one percent of the U.S. money supply so we’ll ignore them.  Here’s what the U.S. money supply looks like for the last three months:

Date Currency Checkable Deposits Other M1
6/1/13 44.29% 55.12% 0.60% 100.00%
7/1/13 44.42% 55.57% 0.01% 100.00%
8/1/13 44.56% 55.24% 0.20% 100.00%

As of August, 2013, the U.S. money supply (M1) was $2.55 trillion.  That’s a lot of money.  But U.S. gross domestic product for 2013 will be about $16.7 trillion.  That means every dollar in circulation will be spent about 6.5 times ($16.7/$2.55).  Economists call that number the velocity of circulation of money.  (In fact, GDP does not really measure total spending, but it will be close.  Asset transactions, for example, are paid for with money, but are not counted in GDP.  Also, previously-owned products such as used cars are not part of GDP.)

As always, my methods are transparent.  Click here to download the Excel workbook that includes the data shown above as well as much more.


Income is the total earned by an individual or household during a specific time period. Economists call income a flow variable, which means it has time units attached.  It makes no sense to say “I earned $1,000.”  A moment’s thought will convince you that there is a big difference between $1,000 per day and $1,000 per year.  Income always has time units attached.

Most of us work for a living and think of our income as what we earn from our jobs.  But there are other sources of income: interest, dividends, and other income flows from lending part of our assets to businesses or governments.  Some people may own rental housing units such as apartment buildings.  The income they earn is called rent.

Many households save part of their income.  There are many reasons for saving: a college fund for your kids, retirement, a down payment on a house, and an emergency fund are a few of the possibilities.  When a household spends less than its after-tax income, the difference is saving.


The accumulation of past saving plus interest, dividends, and capital gains (or losses) is called wealth.  Unlike income. wealth is a stock variable with no time units attached.  At any point in time your wealth is a certain number of dollars.  Wealth increases with additional saving (a flow that increases wealth), interest, dividends, and capital gains (also flows that increase wealth).  Wealth decreases with spending out of wealth (a flow that decreases wealth).  Wealth can also decrease because of capital losses.

The relationship between wealth and saving is typical of many stock-flow relationships:

Wt = Wt-1 + St – Dt

Think of Wt as wealth at the end of this year and Wt-1 is wealth at the beginning of the year. St is saving during the year (including interest, dividends, and so on) and Dt is “dissaving,” the amount withdrawn from wealth during the year.  This is typical of stock-flow relationships in economics, finance, and other fields. (Note that dissaving includes capital losses, if any.)


I hope this article has clarified the relationship between money, income and wealth.  You should understand that money is used to purchase goods and services.  While income and wealth are valued in money units, that is their only relationship with money.  Income is the annual flow of purchasing power earned by an individual.  Most people earn at least part of their annual income by renting their labor to a business or government agency.  Wealth is the accumulation of past saving plus any increases or decreases.  It will help you learn these differences by practicing using the terms correctly.

More on the Deficit and the Debt

[Update Jan. 19, 15:45 GMT-8: I added a link to my expanded Excel workbook.]

There have been a lot of numbers thrown around lately about the deficit and the debt (including mine). Apparently not enough.  This article is more on the deficit and the debt. But there’s more on the deficit and the debt.  On Twitter, Ken Gardner (@kesgardner) posted this the other day:

Ken Gardner's Original Tweet

Ken Gardner’s Original Tweet


Those numbers don’t align with mine, so I asked Ken for his sources.  He pointed me to two websites:


Ken Gardner Reveals His Sources

Ken Gardner Reveals His Sources

A Digression On a Misleading Treasury Definition

The second source is from the Treasury and includes a number of definitions.  Here’s one of them:

Why does the debt sometimes decrease?

The Public Debt Outstanding decreases when there are more redemptions of Treasury securities than there are issues.

While that is technically true, it lies by omission.  The debt decreases when government revenue exceeds government spending.  Only in that circumstance will there be “more redemptions of Treasury securities than there are issues.”

Enough digressions.  Let’s dig into the numbers.

Inside the Numbers

Ken used the U.S. Debt Clock for his debt numbers.  The clock also includes a number of other measures:

The U.S. Debt Clock

The U.S. Debt Clock (click to enlarge)

Sure enough, right there on the fourth line the Debt Clock says:

Debt To GDP Ratio from Debt Clock

Debt To GDP Ratio from Debt Clock

No arguments about the GDP number.  But the debt as reported on the Debt Clock is gross government debt including state and local debt.  In my previous article I used two sources: Treasury and the Federal Reserve.  The Fed reports on two series: Debt Outstanding Domestic Nonfinancial Sectors – State and Local Governments Sector and Debt Outstanding Domestic Nonfinancial Sectors – Federal Government Sector.   On January 1, 2012 those two numbers were $2,985.00 and $10,810.61 respectively.  (All figures are in billions of current U.S. dollars.) The total is $13,795.61. On the same date, the Treasury reported the government debt was $15,582.08. (Click here to download my Excel workbook with the gruesome details.  Debt figures are from the FRED database at the St. Louis Fed.  GDP figures are from BEA.+

GDP (current dollars, 2011 total) Fed. Govt. debt (current dollars, Jan 1, 2012, Federal Reserve data) State & Local Govt. debt (current dollars, Jan 1, 2012, Federal Reserve data) Total Govt. debt summed (current dollars, Jan 1, 2012, Federal Reserve data) Total Govt. debt reported (current dollars, Jan 1, 2012, Treasury Dept. data)
$15,075.70 $10,810.61 $2,985.00 $13,795.61 $15,582.08

One of the main differences is that the Fed excludes holdings by financial institutions.  I attributed the entire difference between the two totals to this factor, a difference of  $1,786.47.  I then added that difference to the Federal Reserve’s figure for federal government debt, giving a total of $12,597.08.  Using that total the debt-to-GDP ratio is 83.56%.  Using federal government debt held by nonfinancial institutions, the same ratio is 71.71%.  The ratio only rises above 100% when state and local debt is included.

Federal Government Debt as percentage of GDP (Federal Reserve data) 71.71%
State & Local Government Debt as percentage of GDP (Federal Reserve data) 19.80%
Government Debt as percentage of GDP (U.S. Treasury Dept. data) 103.36%
Assume Treasury – Federal Reserve = Debt Held by Financial Institutions $1,786.47
Federal Reserve govt. debt plus Debt Held by Financial Institutions $12,597.08
Total Federal Debt/GDP 83.56%


The U.S. federal government debt is owned by many different people, governments, businesses, and institutions.  But it’s important to understand at least the basic components of the debt and how they relate to each other.  I hope this has been a small contribution to this discussion.

The One Trillion Dollar Coin

Most people are aware of the proposal for the U.S. Mint to strike the one trillion dollar coin. The Treasury would turn the coin over to the Federal Reserve.  The Fed would credit Treasury’s account with $1 trillion and the government could continue to spend without exceeding the national debt ceiling.  There are some quibbles about the legality of this proposal.  I’ll mention them and provide links at the end of this article.  My main purpose here, however, is to collect some of the more comical comments — mainly from Twitter — that have been made.  I will, of course, mention my slim contribution early: what should this coin be named and whose image should appear on its face? But before that, I want to talk about the recent demise of this proposal and the language used by White House Celebrity Spokesmodel Jay Carney to make the announcement.  This will just take a minute, then I’ll get to the humorous stuff.

The following quotation from Mr. Carney is via the Huffington Post:

There are only two options to deal with the debt limit: Congress can pay its bills or they can fail to act and put the nation into default,” said Press Secretary Jay Carney. “When Congressional Republicans played politics with this issue last time putting us at the edge of default, it was a blow to our economic recovery, causing our nation to be downgraded. The President and the American people won’t tolerate Congressional Republicans holding the American economy hostage again simply so they can force disastrous cuts to Medicare and other programs the middle class depend on while protecting the wealthy. Congress needs to do its job.

Is simple accounting really that difficult?  Apparently for our math-challenged president, it is.  

A Serious Digression on Default

First, a definition: default is a failure to make payments on debt obligations when the payment is due.  Have you ever been late with a credit card payment?  Or any other debt obligation?  Technically you were in default.  But here’s the funny thing about government default: the government has a steady stream of tax revenue arriving every second.  It is up to government officials — the President, Treasury secretary, and anyone else that is invited to the meeting — to decide the uses to which that tax revenue is put.  They can choose to not pay the debt obligations but let’s be clear on one thing: default is a choice, not a necessity. The government can choose to pay debt obligations and, perhaps, do something that will be very popular with the American public like ending the war on marijuana.  Or scaling back the sexual abuse practiced by the Transportation Security Administration at our airports.  Just as the government spends tax revenue in millions of different ways, it also has millions of ways to cut spending.

 Now that we understand that default is not an automatic result of reaching the debt ceiling, we can relax and have some fun.  My modest contribution was to encourage a competition for names for the trillion dollar coin.


That was the hashtag I proposed on Twitter.  I had no idea there were so many people with so much time on their hands.  Here is the entire response to #NameTheCoin:

Name The Coin 1

Name The Coin 1

Name The Coin 2

Name The Coin 2

Name The Coin 3

Name The Coin 3

Name The Coin 4

Name The Coin 4

The winner is @ProofBlog whose blog, proof-proofpositive.blogspot.com features the coin in all its glory (http://proof-proofpositive.blogspot.com/2013/01/new-trillion-dollar-u-s-coin-freddie.html).  The winning name: the Freddie Krugerrand.  The image, forever etched into posterity, is shown here:

The Freddie Krugerrand

The Freddie Krugerrand


As far as I can tell, the #MintTheCoin hashtag was invented by Joe Weisenthal (@TheStalwart, columnist for BusinessInsider.com).  Here are excerpts from one of his early columns supporting the idea:

Joe Weisenthal On Minting the Coin

Joe Weisenthal On Minting the Coin

It wouldn’t be a real column about fiscal and monetary policy without an excerpt from a real economist.  Prof. Stephanie Kelton (U. of Missouri Kansas City, @DeficitOwl) is one of the best and most articulate, so why not quote her? Good idea:

Prof. Kelton on Mint the Coin

Prof. Kelton on Mint the Coin

For those interested in historical accuracy (really?), Joe Firestone has the most comprehensive article I’ve found. (Suggestions are, as always, welcome.)  He focuses on blog entries and comments, completely ignoring the far more important Twitterverse.

History of Platinum Coin Seignorage in the Blogosphere

History of Platinum Coin Seignorage in the Blogosphere

If you’d like an interactive timeline of blog entries, Corrente has published a semi-working interactive timeline as well as a downloadable table of their data.

But, sad to report, the White House has dismissed this idea without much comment (except the mandatory major error by Jay Carney mentioned at the beginning of this article).  Here is an excerpt from another article by Joe Weisenthal under the headline COINTASTROPHE: White House Rules Out The Trillion Dollar Coin Option To Break The Debt Ceiling.

White House Says No to Trillion Dollar Coin

White House Says No to Trillion Dollar Coin

Comments from Twitter: A Slideshow, Wait for Eleven Slides

Rather than present these one at a time, I’ve decided to display them as a slideshow.  The reason is simple: creating slideshows in WordPress is difficult and I haven’t made myself crazy today (yet).  This should do it.

[portfolio_slideshow include=”1267,1272,1273,1274,1275,1276,1277,1278,1279,1280,1281″ size=large]

Conclusion and a Few More Serious Notes

One obvious question: Is this really legal?  Apparently it is.  The relevant section of the U.S. code is 31 USC § 5112 – Denominations, specifications, and design of coins, specifically, section (k): “The Secretary may mint and issue platinum bullion coins and proof platinum coins in accordance with such specifications, designs, varieties, quantities, denominations, and inscriptions as the Secretary, in the Secretary’s discretion, may prescribe from time to time.” (http://www.law.cornell.edu/uscode/text/31/5112)

There has been some debate about the meaning of “platinum bullion coins.”  Apparently this means that the coin would have to contain $1 trillion of platinum.  Paraphrasing Bill Murray from Ghostbusters, “That’s gonna be one big coin.” However, the second part of the clause, “proof platinum coins” would appear to give legal authorization.  (A proof coin is one struck, but never intended for circulation.  I think it’s a pretty good bet that the trillion dollar coin would be a proof coin.)

Some people have expressed surprise and wonder that this is the way money actually works.  Surprise!  The dollar bill in your pocket has no intrinsic value and is not backed by gold, silver, weasel pelts, whale teeth, or any other commodity money.  Like most countries, the U.S. money supply is fiat money meaning that it only has value because we all accept it in exchange for valuable goods and services. (Whale teeth were actually used as money in Fiji, although calling them commodity money seems a stretch.  After all, commodity money is supposed to have use value as well as money value.  Whale teeth would, presumably, only be useful to whales.)

If nothing else, this episode has taught quite a few people about money and fiscal policy.  And it is among the best examples of economist “humor.”  The very best humor is stories like this that have elements of truth, teach something about economics, and create fun.  Can’t do much better than this.