Eric Tymoigne

Lewis and Clark College

Levy Economics Institute of Bard
College

Public debt: Outstanding U.S. Treasury securities (USTS), includes

both marketable and non-marketable securities:
Marketable: mostly Bills, Notes, Bonds, and TIPS
Non-marketable: United States notes, Gold certificates, U.S.
savings bonds, Treasury demand deposits issued to States and
Local Gov., all sorts of government account series securities held
by Deposit Funds.

Public debt held by the public: USTS held by entities outside

the United States Government. Entities includes, Federal
Reserve, S&L gov, foreign gov, individuals, and other non-US
gov entities.
Monetary sovereignty: Government that sets its unit of
account, issue liabilities only denominated in that unit of
account, monopoly issuer of unconvertible final means of
payment denominated in that unit of account, power to tax and
to determine what is accepted in payment of taxes.

Realities:
1- The public debt is a financial asset for the non-federal
government sectors.
2- Treasury decides what the public debt is and what part is
subject to the statutory debt limit.
3- Government deficit lowers interest rates, public debt
prevents fall
4- The central bank and the Treasury collaborate closely to
keep interest rates stable.
5- The Treasury chooses its financial operating procedures:
debt limit, primary market participants, coupon rate

Myths:
1- The Treasury must borrow funds to spend, and funds
that are provided by the central bank lead to inflation
2- The cost of borrowing is not controllable by the
government
3- The government can control the size of its public debt
4- Government securities need a rating
5- The government issues bonds because it is in deficit.

Flow of Funds data are divided in three broad sectors: Domestic

Private, Government, and Foreign.

ADP

LDP

AG

LG

AF

LF

FADP

FLDP

FAG

FLG

FAF

FLF

RAF

NWF

RADP NWDP

RAG NWG

FA: Financial Assets, FL: Financial Liabilities, RA: Real Assets, NW: Net
Worth

For every lender there is a borrower:

(FADP FLDP) + (FAG FLG) + (FAF FLF) 0

Simplify by assuming a closed economy with no debt in private

sector and only the Treasury in the government sector:
FADP FLGT

Assume that the government wants FLGT =

0:
Let securities mature and do not repay securities holders:

100% tax => FADP = 0

Switch to another liability of the government: repay with
Federal Reserve liabilities (Credit the bank accounts of
treasuries holders and inject reserves in banks, or pay
with FRNs): FADP FLGT => FADP FLGFR (Main way
today)
Switch to a Treasury financial instrument not considered
a liability (Coins treated as equity): FADP FLGT => FADP
NWGT

Some arbitrariness in determining what is part of

public debt:

In this context it is critical to realize that the stock of reserves, or money, newly issued
by the government is not a debt of the government. The reason is that fiat money is
not redeemable, in that holders of money cannot claim repayment in something other
than money. Money is therefore properly treated as government equity rather than
government debt, which is exactly how treasury coin is currently treated under U.S.
accounting conventions (Federal Accounting Standards Advisory Board (2012)).

Problem: this does not stand scrutiny:

Federal Reserve: FRNs and reserve balances are its liabilities
Treasury: Public debt includes unconvertible monetary

instruments:

US notes (never convertible), silver certificates, gold certificates, old goldconvertible Federal Reserve notes (convertibility has been removed)

This unconvertible monetary instruments are not

subject to the statutory debt limit.

There is another way to bypass the public

debt ceiling beyond minting coins, taxing,
issuing Fed IOUs: issue United States
notes.
To reduce the public debt, replace old red,
blue, and yellow currency by Green
currency: would reduce public debt by
about $500 million.

Green currency
Federal Reserve Note
Unconvertible
Not part of public debt
(Caveat: some old FRNs redeemable for gold at the
Treasury are part of the public debt)

Red currency
United States Note
Unconvertible
Part of public debt but
Not subject to statutory debt limit
Not issued since 1968

Blue currency
Silver Certificate
Convertible until 1968
Part of public debt but
Not subject to statutory debt limit

Federal Reserve balance sheet:

Assets
A1: Credit market instruments
(Securities)
A2: Loans to domestic banks
(Advances of reserves to
domestic banks)
A3: Gold, foreign exchange,
and SDR certificates
A4: Treasury Currency (Coins
held by the central bank)
A5: Other assets (buildings,
furniture, etc.)

Liabilities and Net Worth

L1: Vault Cash and Cash in
Circulation (central banknotes
held by banks and the public)
L2: Reserve balances (a
checking account due to
banks)
L3: Checking Account due to
Treasury and Banknotes Held
by Treasury
L4: Checking Account due to
Foreigners and others and
Held
2 Banknotes
3
4 by Foreigners
5
3
and others
3
L5: Other liabilities
(including
net worth)

Monetary Base: L1 + L2 = A1 + A + A + A + A L L4 L5
G leads to lower L3 and T leads to higher L so deficit leads to lower
L3 and so higher monetary base. Usually L2 goes up => excess
reserve in banking system => FFR goes down to zero.
How to remove excess reserves and prevent fall? Fed sells
Treasuries to maintain FFR on target => Treasury issuance
replenishes Feds treasuries holdings and drain reserves

The Treasury and the Federal Reserve talk on a

daily basis to coordinate their financial operations
in order to make sure that the FFR stays on target:
Fed: OMOs
Treasury: Tax and Loan Accounts, Treasury targets of $5

billion in L3 until 2007 (helps Fed to estimate expected

size of non-borrowed reserves)

From 2007 to 2011:

Treasury: Supplementary Financing Program T-Bills +

massive transfer of funds to L3 (almost drained its T&L

accounts from $70b to $2b): 600 billions of reserves
drained at peak (November 2008) to help maintain the
FFR around the 1.5 to 2 percent target .

The main economic purpose of the issuance of

Treasury securities is for interest-rate stabilization
Self-imposed financial constraints may add another
purpose: funding of Treasury.
Treasury, however may issue more treasuries than it
needs:
US: SFP T-bills issued at the request of the Federal Reserve

[] apart from Treasury's current borrowing program

(Treasury statement) to drain reserves from the banking
system, [in order to] offset the reserve impact of recent
Federal Reserve lending and liquidity initiatives (NYFed
statement)
Australia: Federal government ran a surplus and issued
Treasuries

In the early years of the American monetary system, the

fiscal operations of the colonies Treasury were much
simpler: no central bank, no primary market, and no debt
limit.
When the colonies decided to issue their own currency, they
just got a printing press.
Unconvertible bills were injected when the Treasury spent
and drained when taxes came due. They circulated at par
because people anticipated that they would be able to pay
their taxes to the government at a later date.
Pretty clear that taxes were not a source of funds: they
withdrew bills from circulation and, through expectation of
future taxes, maintained the circulation of bills at parity.

Today:
Treasury decided to stop issuing monetary instruments
Treasury forbidden to get a credit line from Fed
Treasury accepts competitive bid for Treasuries: choose not to set yield rate
Fed cannot participate in primary market from Treasuries
Debt ceiling

However:
All these self-imposed constraints can be removed or bypassed: it is a matter of

self-imposed law and will, no physical constraint

Treasury keeps some control over its cost of borrowing directly through noncompetitive bids and tightly regulated competitive bid tilted to its advantage, and
indirectly through monetary policy.
Central bank still indirectly fund the Treasury by funding primary dealers and it
acts as market maker in the Fed Funds market by using treasuries.

Self-imposed funding constraints hide the economic purpose

of taxes and bond issuances.

No, if it wants, Treasury is able to fund itself directly through

monetary creation either with the help of central bank or by
creating its own monetary instruments (coins, US notes,
demand deposits, time deposit): it is matter of choice, not a
matter of obligation
Central bank already indirectly funds Treasury: Fed owns
over 10 percent of treasuries
Spending is potentially inflationary, not the funding method:
it is the speed at which spending occurs, not the means
used to obtained funds that matters for inflation

Yes it is
Auction mechanism to control yield
Monetary policy to control the yield curve

Most Treasury spending is not

discretionary, and tax receipts are not
discretionary.
Deficit is determined by the desired net
lending/saving of domestic private sector
and foreign sector

View of S&P:
Credit risk = economic risk (capacity to pay) + political risk

(willingness to pay)
There are two types of sovereign debt: Domestic-currency
denominated and foreign-currency denominated
Governments that can tax and issue their own currency have the
full capacity to pay domestic-currency-denominated debt
Inflation risk is a form of default risk

Problems:
Capacity to pay is unlimited for monetarily sovereign government
Inflation is not a form of default: not controlled by Treasury + higher

inflation raise tax receipts, which following S&Ps logic, lowers

default probability
Willingness to pay may be an issue but extremely rare (much lower
probability than 0.02 percent over 5 year: AAA rating)

Treasuries of monetarily sovereign gov

play a crucial role in the financial system:
Helps to comply with capital regulation
Provide a default-free liquid asset upon which all

other securities rely: risk-free rate

Even when having a fiscal surplus,

monetarily sovereign government may
still issue treasuries, and usually will
unless they find an alternative means to
help the financial sector: Australia