[Update 1 September 7, 2024 to add a few comments from Brian and to add a link to my Excel workbook.]
[Update 2 September 21, 2024 to add some more analytical and quantitative details. Also an updated Excel workbook.]
[Update 3 October 3, 2024 to delete the statistical material entirely. I mistakenly fell into the trap of not developing a full model of the money supply. In other words, there was at least one omitted variable. After several attempts at developing a more robust model, I gave up.]
Our old pal Brian Wesbury noticed something interesting. Treasury can change the money supply. They do this via their transactions account at the Fed, the Treasury General Account (TGA). It’s important to note that TGA is not part of M2. In theory, when Treasury spends from TGA, M2 increases and conversely. In practice, until recently TGA was less than 1% of M2 so the quantitative impact of Treasury actions on M2 was minor. But in the week of August 7, 2024, TGA was 3.6% of M2. That’s enough to make a difference.
This is about TGA and M2. (If you’re a little rusty on the difference between government spending and the money supply, I’ll add an explanation later.)
Brian Wesbury
Brian’s full thread is a pdf at the end of this article. But here’s the gist of his argument (emphasis added):
For decades the Treasury held roughly $5 billion in the Treasury General Account (TGA) at the Fed. This is the Treasury’s checking account at the Fed…generally used as a cash flow device. Now it has become a slush fund with roughly $800 billion held in it. The TGA does not count in the M2 money supply. If the Treasury taxes or borrows it can withdraw money from M2 and hold it in the TGA. In other words, the Treasury can now tighten monetary policy by putting money in the TGA. (As an aside, this is what Modern Monetary Theory wants.) Building the TGA to such a high level is one reason the M2 money supply has contracted in the past 18 months.
Conversely, if the Treasury wants to ease monetary policy, it can take the TGA and spend it, therefore putting it right back into the banking system and the money supply.
In the week of August 7, 2024, M2 was $21.1 trillion. TGA was $770 billion, about 3.6% of M2. In January, 1986 it was 0.16%. TGA is now large enough to actually change M2.
Why TGA and M2 Grew Together Before 2020
Remember Quantitative Easing (QE)? That was a response to the 2008 financial market collapse. From Investopedia (footnotes and external links removed):
To combat the Great Recession, the U.S. Federal Reserve ran a quantitative easing program from 2009 to 2014. The Federal Reserve’s balance sheet increased with bonds, mortgages, and other assets. By 2017, U.S. bank reserves had grown to over $4 trillion, providing the liquidity to lend those reserves and stimulate overall economic growth. However, banks held on to $2.8 trillion in excess reserves, an unexpected outcome of the Federal Reserve’s QE program.
In 2020, the Fed announced its plan to purchase $700 billion in assets as an emergency QE measure following the economic and market turmoil spurred by the COVID-19 shutdown.
During the 2008-2015 QE cycle, M2 and TGA both increased rapidly. The Fed was inflating the money supply; 60% of the all the M2 in circulation was created in the past 16 years. And about 95% of the TGA was built up during that same period. The Fed was pumping out money like mad and Treasury was stashing that money in the TGA.
Why? Brian believes this is one path of several leading to the implementation of Modern Monetary Theory (MMT). I won’t dignify that “theory” with a discussion, but I will note that its proponents seem unfamiliar with the long history of sovereign defaults. Also, look up “failed Treasury auction.” MMT flies in the face of nearly a century of solid research showing pretty conclusively that excessive increases in the quantity of money in circulation inevitably lead to inflation in the long run.
The reason Treasury stashed so much cash in TGA was essentially to create a spending reserve. Treasury wanted to avoid (or at least postpone) the effects of a government shutdown caused, say, by Congress refusing to raise the debt ceiling. A large pile of cash is a pretty good buffer. Treasury will not worry as much about the debt ceiling.
The TGA Multiplier
When the government reduces its balance in the TGA by $1, M2 increases by $1. The difference between the TGA multiplier and the classical reserve-deposit multiplier is that withdrawals from the TGA are spent immediately, directly increasing M2.
Review of Money and Government Spending
In brief, changes in government spending do not affect the money supply. The government pays for its spending from two sources: taxes (broadly defined) and borrowing. Suppose our government decides they need a million gold-plated swizzle sticks. They get them at the bargain price of $20 each. That’s $20 million in new spending. The government, naturally, sells $20 million in bonds, taking in $20 million in money. But — here’s the trick — when has any government ever sat on $20 million in new cash? They don’t. They use it to buy the swizzle sticks, restoring the $20 million in money back into the economy. (As we’ve just seen, changes in TGA are a different matter.)
Central banks have the power to create money. In the U.S. the central bank is the Federal Reserve System. The entity that decides monetary policy (basically whether to increase or decrease the money supply and the amount) is the Federal Open Market Committee (FOMC). That group meets ten times a year. Attendees are the seven members of the Fed’s Board of Governors and all 12 presidents of the regional Fed banks. Votes on monetary policy are cast by the seven Governors, the president of the Federal Reserve Bank of New York, and four of the remaining 11 bank presidents on a rotating basis. (Contrary to what the Fed says, all 12 presidents attend every meeting.) When the FOMC votes to increase the money supply, here’s what happens.
The Fed sends a message to the New York Fed to buy more government securities. They pay for it out of their transactions account. That account, essentially, has an unlimited balance. Here’s a handy rule of thumb:
When you have the power to create money, your checks never bounce.
“But Dr. Lima,” you ask. “What does the Fed use to back the new money?”
Absolutely nothing. Money has value because we all agree to accept it in exchange for goods and services. When, say, the central bank expands the money supply very rapidly, a hyperinflation can result. During hyperinflations, people often resort to barter or use an alternative medium of exchange.
Conclusion
Here’s Brian Wesbury’s tweet thread:
