The Government Doesn't Pay In Cash-It Is Credit Only
Contrary to the thoughts of many, the US Government does not pay for things in cash. Instead, it pulls out the charge card and swipes it. This is why the US Debt keeps skyrocketing.
It is also why the economic model that most built for themselves is completely wrong.
Understanding how the monetary system works will enable us to size up the opportunities as they are presented. Keep in mind that most are amiss in what they believe, only picking up tidbits here and there.
Government Money
This is something that many discuss. It is also completely untrue. The US Government does not create its own money. Nor has it in some time. Neither Congress or the US Treasury is in this business. It is true the US Mint "prints" the physical money, but that is not who creates it.
When Congress passes a multi-trillion dollars spending bill (hypothetically speaking), many seem to believe the government just prints up USD to pay for it. This is untrue.
Instead the US Treasury creates securities. This is what it "prints". These are taken to the Fed and sold at auction. Like anything that is sold, payment is required. Thus we see the USD coming into the TGA (Treasury Government Account) which is at the Fed. This is where the government keeps its money.
Once the USD is there, the money can be sent out for whatever Congress passed.
But where did the USD come from if it wasn't created?
The answer is in the fact that it already existed. The dollars that are used to buy Treasuries are part of the existing money supply (which is different from the monetary base). It was resident in either the domestic or international banking system. No new USD was created to pay fund the spending.
Of course, there is accounting that is required. When the securities are sold, these are assets to PIMCO, the Chinese, ECB, or the California Firefighters Pension Fund. What was once cash is now a security that has not only value but pays interest.
Now, anyone who understands accounting know if there is an asset somewhere, a liability also needs to show up. Guess who gets this? If you said the balance sheet of the US Government, you are correct. The debt increases by the amount of bonds sold. Naturally, this amount is owed PLUS the interest.
Hence why the Government does not pay in cash, only credit. It is also why government money has nothing to do with the government.
USD Liquidity Crisis
There is a global liquidity crisis in USD. This is something that also bewilders those who believe that US Government is the one who creates the dollars. Now that we understand that is not the case, it is easy to see how the stimulus actually fed into this problem.
How does this occur?
Simply put, there are both domestic and international buyers at the auctions. When international buyers purchase Treasury securities, they pay in USD. This brings the money back on-shore, which ends up in the domestic banking system.
This is coupled with the fact that Fed spend at least half of the last 14 years engaged in QE only made the situation worse. Here is where we see those closest to the Fed benefitting the most. It occurs because the dollars end up locked in the banking and financial system. It does not make it to the general economy, which is also why the easing actually tightens financial conditions.
Naturally, the domestic economy suffers but the global economy really takes a hit. The USD is the reserve currency, which resulted in an entire borrowing and lending system based upon this. This is estimated to date back to the 1950s and operates outside the view of any regulator. Hence it is hard to get a grasp on exactly how big it is.
Nevertheless, since the bursting of the dotcom bubble, the withdrawal of Dollars from the international system has only accelerated. This is led to, in part, the Great Financial Crisis. Sadly, it just keeps getting worse. All the stimulus and easing is starving the global economy.
Hence, there is not enough money to keep it going.
Which means that economic conditions have no choice but to tighten. If there is not enough money out there, economic activity contracts. This is exactly the story the bond market is telling us with the yield curve.
The Fed Got It Wrong
So while everyone is complaining about the rise in prices, which resulted from a supply chain shock, the Fed is only going to further the problem by tapering. The market believes that interest rates will rise as a result but history shows that this is not the case. Interest rates do not rise when economic conditions are tightening. Banks are unwilling to lend when that happens, meaning all the Fed's efforts are for naught (which is true in most cases anyway).
The Fed believes there is no demand problem by looking at the data. Here is where I disagree. It looks like there are issues all over the place with this. We know the lockdowns pulled demand forward. There are also some industries where allocations are taking place, causing purchasing managers to place bigger orders knowing only part will be filled.
This leads everyone to believe there is demand that is unfulfilled.
What is most likely to happen is that once the supply is in stock, the demand will magically vanish since it was not truly there to begin with.
We have seen this story before. It is the path that is followed out of a recession. Now we are going to follow it, probably right back into one.
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