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Have we learned anything over the past 4 months? Yes. What the Fed does matters to financial markets. FWIW - I don't think the Fed was/is responsible for the carnage this week in equities (and to a lesser extent in commodities). While there were a lot of Fed speakers sounding bearish, the Fed rate hike odds didn't change this week (they've been predicting 3 straight 50bp rate hikes in each of the May/June/July Fed meetings coming up for the last month or so). So there was no change in expectations as to the Fed from what I can see by markets. To find a possible reason for the upset, one must look to the US Treasury as we always have to for monetary goings-on. Fed tax receipts have been booming this year, but April (as the 2021 tax filing deadline) has been one for the record books. Here's a couple of charts: the first, tax receipts for the last few months, and the next one April US Treasury receipts vs expenditures for the last 25 years. The effect of this huge Federal tax receipt week (and large surplus) was to reduce US domestic bank sector reserves by $466b! This was a 12.3% reduction in bank reserves in one week!! You can see this in the comparison of the Fed's balance sheet between April 13 and April 20. Basically the Fed moved reserves from the banking sector to the US Treasury's general account. This was a huge reserve drain from the banking sector. To put it in perspective, the Fed has said that it wants to shrink its balance sheet by $100b a month (which also has the effect of removing bank reserves). So the US Treasury did in one week, what it will take the Federal Reserve to do (starting in May) in more than four and a half months. Another way to think about it is that in mid-Sept 2019, a relatively small corporate income tax draw (when bank reserves were at $1.5t) caused a much smaller reserve drain that sent short-term interest rates spiking and forced the Federal Reserve to come in with repo mop-up operations the next day. The private sector really felt this big withdrawal of liquidity - especially in the latter part of the week as the effects started to ripple into a strengthening of the US dollar (gold sank on Wed-Fri by over $60/oz because gold is inversely correlated to dollar strength and is very sensitive to changes in the supply of/demand for US dollars). So what does this possibly mean for the macro economy? I think in the short-term we'll feel it for another week or so but the tax haul is a one-timer and the budget should filp back into deficit mode. Longer-term, I'm still bullish on the US economy for this year and next, but I do think the US budget deficit is falling fast. That's healthy, but if it continues to fall over the next few years and gets as low as 2% of GDP - that might be too low for the US domestic & global economy and could create a very strong USD that could put deflationary pressures on the US and the world. Of course, just because the US economy is fine, equities will feel headwinds from rising rates. The economy and markets can go in different directions and often do. Bill

Mr. Market to Charlie Munger....

So, it seems to me the next big question is what happens to inflation if the treasury bond is paid off at maturity: a) using taxpayer dollars (specifically, using reserves offset by taxpayer dollars) Focusing on a treasury bond being paid off in isolation is the wrong frame, I think. Since the US Treasury needs to run a perpetual deficit, then all its doing is rolling over its bonds and increasing the net issuance. If it tries to run a sustained surplus (ie, paying down its US Treasury security balances outstanding, it unleashes monetary deflation (as it did in 1998-2001). b) using debt purchased by the private sector (specifically, using reserves offset by treasury bonds purchased and held by the private sector) Not sure what you mean here - but this sounds like a) above. c) using debt purchased by the Federal Reserve (specifically, using reserves offset by treasury bonds purchased from the private sector at artificially high prices to reduce interest rates, but ultimately held by the Federal Reserve)? Further, let's assume the market expects the Treasury to perpetually roll maturing Treasuries over into new Treasuries that will be purchased/held by the Federal Reserve. If the Fed keeps buying all of the US Treasuries issued, then interest rates will go negative, banks assets will be nearly 100% reserve assets and the economy becomes moribund. Not because of inflation (though that's possible if the US Treasury deficits are sustained over 10% for multiple years). More likely under normal deficits = 2-4% of GDP, this creates a moribund economy because consumption falls and banks stop lending. Bottom line - you (and that article) are focusing on the wrong thing - Treasury securities. IMHO, inflation appears if the US Treasury runs multi-year deficits of >10% of GDP. Its the spending, not the Treasury issuance that comes after the spending. Bill

Also, when you say it (the treasury) first creates reserves I'm assuming this is the act of manifesting money, right? Is converting reserves to currency or treasury securities part of ensuring the Treasury's account doesn't have a negative balance? The best way to visualize all of this is with an accounting ledger approach to all of these transactions. The blue side is the consolidated Fed govt (Treasury + Federal Reserve). The green side represents the private sector. The first payment flow is the US Treasury making a payment (i.e., issuing stimmie checks). The US Tsy gives the Fed a payment order and the Fed moves reserves (settlement balances) from the Tsy's Fed acct to JPM's Fed acct. This creates both a reserve asset and a deposit liability for JPM. The non-bank private sector gets a new financial asset in its deposit account (with no offsetting liability). That's why only US Treasury deficit spending creates new financial assets for the private sector. In the second payment flow, the US Treasury issues a bond. This removes the reserves and deposit from JPM and moves reserves at the Fed from JPM to the Treasury. Notice that this transaction does not change the net asset position of the private sector. It just substitutes one form of govt liability (reserve) for another (T-Bond). The last payment flow is the Fed buying a Treasury security. Of course it can also work the other way. But the key point is that the Fed buying (or selling) Treasuries does not add (or subtract) net financial assets from the private sector. It just changes the form of the asset. Hope this helps. Bill

2023 is when things could REALLY get interesting. What if inflation is still high single digit. And labour markets are still super tight. And the economy is still doing OK. And the Fed KEEPS TIGHTENING. Very likely - that's why I bought a ton of TLT Jan 2024 LEAP put options (also Jan 2023 LEAP puts too). We talked about this last summer in various Federal Reserve threads that long rates could rise a lot. And I'm not really a macro investor. Bill

Bill, what are you thoughts on the reliability of yield curve inversions and recessions? I think they are ok as indicators - though the original thesis by Cam Harvey in his 1980s paper was based on the 3mo-10yr differential. That's the one I watch. My own thoughts were that the chatter about the brief 2yr-10yr inversion is a head-fake as the long end of the yield curve will rise a lot over the rest of the year. That's bullish, BTW, for the US economy. Stock market, maybe not so bullish, who knows? Bill

a government is funded solely with newly created money. (Inflation becomes the de facto tax.) Close! The sovereign (ie, federal govt) needs to spend to obtain resources, so it imposes tax liabilities on its citizens to create the private sector demand for its money. It then mandates that its money is the only thing that the citizens can use to extinguish these sovereign tax liabilities. So it must run deficits (spending > taxes) to furnish its citizens with its money that they need. If it spends too much vs tax receipts it can create inflation. Keep in mind that the US, as reserve currency, must also provide its money to the foreign sector as well who also want to net export to us in order to get US dollars (trade deficit). This is because the rest of the world wants to save a portion of its rising wealth in US dollars and US dollar assets for safety. That's why the US govt can run a much larger deficit safely versus other countries. We have the world's reserve currency and the rest of the world wants/needs it. a government is funded solely by long term bonds nope - a sovereign govt is funded by three types of liabilities - currency, reserves and treasury securities (bonds/bills). It first creates reserves via its spending and then converts most of the reserves into either currency or treasury securities based on the proportions demanded by the private sector (by far they want treasury securities for earning a risk-free interest income). the bonds are purchased/held to maturity by a government-owned bank that can create money. The govt-owned bank (I presume here you mean the central bank) does not create money. Only the US Treasury does. The central bank runs the payment system between the banks and between the banks and the US Treasury. The central bank clears payments by using settlement balances (ie, reserves) on deposit at the central bank. These settlement balances never leave the central bank. Lately, the central bank has tried to influence long-term rates on Treasury securities by buying these securities in the open market and paying for them with new reserves deposited to the banking sector's reserve accounts at the Fed. Again these reserves circulate amongst the banking sector but never leave the Fed's payment system and never go into the private sector. There is no increase in private sector "liquidity", money or anything else. There is only a lowering of interest rates which the central bank hopes will increase economic activity. It seems to me Hoisington is banking on Scenario 4 long term, with government excess ultimately stifling private sector growth Monetary deflation only occurs if the sovereign govt does not provide enough growth in the supply of money to support the real economy's growing commercial activity. In today's monetary system with no link to gold, that happens if the Federal govt tries to run a budget surplus (like it did from 1998-2001). That unleashes monetary deflation which grinds down economic activity until tax revenues fall enough that the surplus slips back into deficit. That's what happened in 1998-2001 -- the deflation caused the US economy to go into a long recession from 2000-2002. Under the old US system, when the dollar was subordinated to gold (dollars could be exchanged to gold on demand), there were times when the average increase in the world's gold supply vs above-ground inventories of ~2% per year did not supply enough money to support fast economic growth. The private sector would then increase its borrowing/debt to maintain consumption/investment. The economy would then suffer a debt deflation/banking panic every decade or so. A good example of this was the post US Civil War period when dollars were convertible to gold, US banks issued their own money (backed by their gold reserves), and there was no Fed (ie an Austrian economist paradise) to support the interbank payment system. During that time period, the US suffered severe deflationary depressions in 1873, 1884, 1893 and 1907. The Fed was created soon after in 1913 because despite the Austrian economists, this boom/bust system was intolerable to the US citizenry. FWIW - I think this inflation will recede on its own (with or without the Fed) because the deficit is declining rapidly and supply will eventually catch up to demand. The US economy is fundamentally strong because the household, corporate and banking sectors have not all been in this good a shape from a balance sheet perspective in a long time. It is also benefiting from the mini-baby boom of the early 90s (millenial generation) currently populating the 25-34 year old age group, which is peak household/family formation. This is a huge tailwind for housing and general consumption for the US economy interrupted temporarily by the pandemic's forced suppression of consumption. I enjoy the questions/comments - please keep them coming as long as I'm not boring everyone. Bill

Also, if the government continues running 5% annual deficits AND the Fed buys up a large percentage of the treasuries required to fund the deficits then the market will expect inflationary pressure. Fed buying of Treasury securities does not fund the deficits. US Treasury deficit spending 'pre-funds' the Treasury security issuance. There is no "crowding out". The US Treasury spends, then issues securities to replace the reserves/deposits its spending creates. It's a circle of asset replacement for the private sector (reserves created by spending then being replaced with Treasury securities). Think of it this way. A bank gives you a free $100 in your checking account. It then comes in and replaces the $100 in your checking account with a $100 in a time deposit. This is what US Treasury security issuance is = moving the same amount of money from a checking account to a time deposit so the private sector can earn a higher interest rate on the free $100 that started the process. But the $100 time deposit (ie US Treasury bond) does not require new money - it was already there in the free $100 you received in your checking account. Thus = no "crowding out". Fed open-market buying of US Treasury securities serves a different and separate goal; which is to shrink the supply of US Treasury securities along the yield curve in the private sector's hands to force longer-term interest rates lower. But this lower rate is not needed by the US Treasury (see next comment below) to issue its securities. It issues them with or without these Fed actions at any interest rate it wants. interest rates will reflect people's expectation of future government deficit spending as well as the degree in which debts will be repaid with devalued currency. Treasury security interest rates are whatever the Federal government wants them to be (even without Fed buying). That's because the US Treasury spends first, creating both deposits & reserves in the banking system, then issues securities to withdraw the reserves and replace them with interest-earning assets for the private sector. If the US Treasury didn't issue securities, then reserves & deposits would choke the banking sector and interest rates would fall to zero (or less). Thus, US Treasury security issuance can be properly seen in this context as more of a reserve maintenance/hygiene function than "borrowing". The "borrowing" is the initial US Treasury spending. It's important to remember that the Federal government has three types of liabilities to the private sector (currency in circulation, reserves, Treasury securities). Why are US Treasury securities the only one of three that we consider liabilities/debt of the Federal govt? We saw this effect in 2021, when the US Treasury ran down its general account at the Federal Reserve from $1.7t to $150b in 5 months & didn't issue much in Treasury securities. I shake my head at what is written in mainstream publications about how the monetary system works. Bill

1.) how high do you see interest rates getting in the coming months? Do you think we could see 3% right across the curve (2 year to 10 year)? Is 3.5% possible (likely?) for the 10 year in 2H should inflation remain elevated? I think the 10-yr yield will go over 5% by end of 2022. I predicted this on another forum in January of this year. I say that because short-term rates will be ~ 3% and the yield curve will uninvert/unflatten as the year progresses. 2.) when the Fed raises rates, is housing not the main mechanism to slow the economy? So if housing continues to rip in the US does this not suggest the Fed will be forced to raise rates much higher than what is currently ‘priced in’ by the market? I think the Fed believes this but I don't. I have said before I think a lot of what the Fed does makes very little difference - except when they go to extremes (zero rates, rates >12% where it makes sense to liquidate productive assets that earn 10% ROEs). 3.) balance sheet run off: how do you see this impacting interest rates/the economy? Especially if it happens quickly? I think you posted on this in the past… can you point me to what thread you posted your thoughts in? I think people way overstate in negative ways the effect of the balance sheet run-off. The Fed does nothing but asset swaps. When it does QT, in effect, it is removing reserves (useless assets) in exchange for Tsy securities (productive assets). The private sector benefits from QT - it loses from QE. 4.) where do you get your information? Web sites? Podcasts? Your thesis that the current environment most closely resembles the US 1940’s is also shared by Lyn Alden. I've been reading about this stuff (monetary plumbing) for 20 years. Only just starting to make sense. I don't read anything from Lyn Alden after I initially read some of her stuff in late 2019. I thought that she didn't understand how the Fed works when she claimed "the Fed was pumping liquidity into the stock market". Not many worth reading anymore, IMHO (not just Lyn). Bill

BTW - I also believe inflation has crested and will start to fall (regardless of what Fed does - which most of what it does is pretty useless anyway, LOL). My mental model of what is going on with inflation is still the US post WWII. During the war, the US govt suppressed consumption to divert resources to military production. In addition, the Fed purchased Treasury securities directly from the US Treasury in order to fix 10-yr yield at 1% as the Federal govt ran deficits = ~ 12-14% of GDP. Many similarities to the recent pandemic response. After the war, CPI ran up to 10% as consumption resumed and demand outstripped supply. There was no Federal Reserve response to the burst of inflation since its hands were tied by its agreement to fix the rates on US Treasury debt. But inflation fell to basically zero by 1949 anyway. Essentially the free market delivered increased supply to meet demand. I think this is where we are now. The US economy is ripping. Household balance sheets are in great shape. As I said, upthread demographics in the US are creating a tailwind of demand. Federal tax receipts are booming which indicate strong employment and employment incomes. Even Fed hikes are bullish because the US household sector is positively positioned to short term rate increases (more money market type assets than consumer debt (which is fixed anyway)). Even the Fed QT is bullish as the private sector needs more US Treasury securities (and can't use the bank reserves that the Fed created). Very bullish here on US economy. Equities will have a headwind due to rising rates - but the Fed doesn't care about the stock market. Its attitude is "we gave you zero rates for two years and you apes bought crypto, NFTs and shitcos and made money. What more do you animals want? We are going to take some of that back now, thank you, very much" Bill

That will be the end of the housing boom, imo. I don't think so. US demographics are a tidal wave of demand that still has not crested, IMHO (45m 25-34 yo - that is prime household & family formation age). US household sector has the balance sheet and the income to keep buying. Income (not rates) is the no. 1 determinant of home purchase decision. Also, 95% of US mortgages are 30-year fixed (unlike GFC) - so rate rises cause no stress to existing homeowners. Housing starts still setting multi-decade records at 1.7m (numbers not seen since early aughts). I am very bullish on US economy (not necessarily on equities - the two can go in different directions). Bill

interesting article on the situation in 1948 which indeed seems similar to what we have today: That's what I've been saying as well, that today's situation is more similar to post WWII rather than the 1970s for the same reason - government suppressed consumer demand in both cases (WWII, pandemic). Bill

Fed tightening into a slowdown can cause a recession. I may be a voice in the wilderness on this - but I think Fed "tightening" is actually bullish for the US economy. Most commentators have got this wrong because they don't actually think carefully about what the Fed is doing when it is "tightening". And when I say tightening I mean two things: 1) Fed raising the rate it controls (interest on excess reserves and/or fed funds rate which is basically moribund in a world of excess reserves). 2) Fed shrinking its balance sheet by letting its Treasury securities mature without rolling them over into buying new replacements and/or selling its Treasury securities outright before they mature. Let's take these one at a time. 1) Raising rates At this point, most forecasting models are guessing that the Fed will take short-term rates to 3% by sometime in 2023. Do we really think the US economy can't handle 3% rates? The US household sector has never been in better shape from a balance sheet perspective in several decades. HH Debt to GDP, HH Debt Service to Disposable Personal Income, and Household Net Worth - all best they've been in at least two decades or more. But another fallacy in the raising rates theory is that US households are hurt more due to the rising cost of their liabilities outweighing the interest income on their assets. So let's take a look at aggregate US household balance sheets from the Fed's quarterly Z1 report. I've highlighted in yellow the important assets & liabilities. Most households' main asset is their principal residence ($38t). In addition, households have a total of $17.5t in interest-earning assets (checking deposits, time deposits, & money market funds). As rates rise, these interest-earning assets will add to household incomes. Now let's take a look at the liability side of the household balance sheet. Main liability is the mortgage on the principal residence ($11.7t). As rates rise, refinancing activity may stop, but payments won't increase. That leaves consumer credit (credit cards, auto loans, student loans). Here too, most of this consumer debt is fixed in the short-term. So rising rates do not directly lead to rising interest expense. Net, net - I reckon, US households have ~$17.5t POSITIVE EXPOSURE to rising rates. If short-term rates go from zero to 3%, that's an additional $525m in new household interest income! 2) Shrinking the Fed balance sheet: Here too, if one thinks about what the Fed is actually doing in detail, one can't help but come to the opposite conclusion. The Fed shrinking its balance sheet is not really "tightening" liquidity -- at the margin, it is actually increasing "liquidity". When the Fed does QE it is pulling a Treasury security from the private sector and replacing it with a reserve balance. But as I've said before, reserve balances are frozen at the Fed and pretty useless to the private sector since only banks can hold them. So to control long-term rates, the Fed is tightening the supply of Treasury securities by reducing the quantity available to the private sector and replacing them with frozen, illiquid assets. Proof that the Fed went too far is that it had to open the reverse-repo window so that the private sector could borrow $1.6t of US Treasury securities daily lest the lack of interest earning assets for the private sector would cause rates to go below zero. Thus, now as the Fed is shrinking its balance sheet, the supply of US Treasury securities available to the private sector will increase. This adds liquidity and supply. The Fed is probably late on this and so its rate hikes are spiking the short-end of the curve upwards while the long end is still low because the Fed won't start adding to the supply of Treasury securities until May. Bottom line - increasing the supply of US Treasuries is a good thing for the US economy. One final comment, in recessions, Federal tax receipts always fall since 80% of all tax receipts come from payroll deductions (income tax, social security, medicare taxes). Thus tax receipts give one a real-time indicator of employment and employment income. So how are Federal tax receipts doing (in real-time)? In a word, they are booming! This is data I scrape from the US Treasury's Daily Statement (basically a daily cash flow statement for the US govt) and is through yesterday's report. Don't let the talking heads and their discussions about Fed tightening and yield curve inversion confuse you. I am bullish on the US economy and you should be too. Consumption was suppressed for two years due to the pandemic and now US households have the balance sheet and the employment income to spend and they will spend. That's why commodity prices are rising - demand is strong. One example is housing. Look at US demographics. The fattest part of the US population pyramid is 25-34 year olds. That is bullish for peak household formation - people marrying, having families, buying houses and filling those houses with stuff. We are going to set a multi-decade record for housing starts this year (1.7m) and its only going to go higher over the next 5 years. (That's why lumber is spiking and I am long a lumber saw mill.) Sure - there will be some hits due to commodities, but the US economy will absorb them easily. Of course, rising rates particularly at the long end will be a headwind for equities since they affect discount rates. How equities will do will depend on whether profit growth can outpace the depressing effect of a rising discount rate on those earnings. Bill

What's the right way to think about it? From the seller POV. The sellers we're talking about are smart & and as they look out, they see falling bond prices (and equity values). Not much fun when you are holding a large bond (and to some degree equity) portfolio. Bill

This one seems pretty small to make much of a difference That's the wrong way to look at it. Bill

I would like to point out that Buffett/BRK seems to buy these leveraged bond portfolios (ie, P&C insurers) at the tippy-top of aging, multi-decade bull markets right before big equity market declines. 1966- National Indemnity 1998 - Gen Re 2022 - Alleghany (?) coincidence... or cue ominous sounding music.... Bill

Good to see that Buffett is making an all-cash acquisition and not issuing any BRK stock. I wonder if a superior bid to BRK's offer comes in and, if so, what the break-up fee is. Buffett must really be worried about inflation - he's putting the cash pile to work w/ OXY, Y. What else will he go after next? Bill

Spek - I think you understand it better than 99% of the people out there (even some PhD economists). Bill

Oh no! We're all making more money. The economy is going to crash! Bullish! Bill

Is this a good level to get into DJCO given the BABA blow-up?? No. Bill

Wow - I love this view - I hope you are right!! Think about it - this has been a debacle for Russia. But as bad as it has been for Russia, it has also been bad for China who quietly was neutral/supportive of Putin. But China must be getting increasingly alarmed at the 180-degree outcome from what was expected. Rather than a bolstering of Russia as a strategic rival to the West, Russia is failing militarily, its economy is being destroyed - and even worse, a strengthening of NATO around the US. But what really hits close to home is the focus this invasion has placed on Taiwan. If Russia ceases to be a strategic competitor to the US, the world world swings around US leadership to Taiwan. That's not in China's best interest. So I expect China to make a move to force Putin's hand. China will join the US and other Western countries to force a negotiated peace in Ukraine before this gets any worse for them (both Russia and China). As for the US economy - just look at real-time employment income (via Fed tax receipts on the US Treasury Daily Statement). US households have never been in better shape from a balance sheet & income perspective. They are going to spend now that their consumption is no longer suppressed by pandemic restrictions. Just my 2-cents. Bill

FWIW - no US recession. 1) US economy is ready to boom and will absorb the hits due to commodities. 2) Russia/Ukraine war will be over in 1-2 weeks -- Russia has already lost, strategically speaking. You want to be positioned for the rally in equities that is coming and you don't want to be in commodity plays. Just my 2-cents. Bill

Also - Buffett repurchased a further 4.5m B-share equivalents in the 2 weeks since the 10-K came out. I reckon another $1.4b in common stock at ~ $315-$316 avg price per B-share. Good to see him still buying at prices well above $300 per B-share -- though pace this Q will definitely be lower than last couple of years. Bill

What you describe as « incorrect » may simply be a matter of perspective or even accrual. CB - why you are overly focused on deposits/reserves & coin/banknotes as "money" but not Treasury securities? Treasury securities are money, too. That's why M2 concepts are flawed. Alternatively, why are US Treasury securities considered debts of the government, but currency in circulation and bank reserves are not? If you are going to throw around accounting terms like accrual, then I think you are obligated to think in terms of the domestic private sector's balance sheet and debits/credits. You have to ask yourself a couple of questions. 1) At what point does the private sector's aggregate balance sheet net equity (assets - liabilities) expand? That's what's important - not individual balance sheets but the private sector's balance sheet in total. Think this through in that example of yours. 2) What is the right way to think about the issuance of Treasury securities? As for examples from previous monetary eras - you have to remember that most of those times, the central government's money was subordinate to gold. Thus, any time a breaking of a peg to gold happened due to any number of reasons, it was a devaluation that released the safety valve on bottled up inflation all in one go. That's not the monetary regime we are in today. Always enjoy these conversations, CB! Bill

The bank creates an asset (government debt) and simultaneously creates a matching liability deposit, ie new M2 money that ends up in private bank accounts, ready to be spent. This is an incorrect statement. The key question is not what creates a deposit. The more important question is what creates a net financial asset for the private sector. Let's go through all four types that can affect deposits. First, it is important to consolidate the Fed and the US Treasury as one entity (the central govt sector as fiat obligation issuer) and the private sector (including the domestic banking sector) as the other. 1) The Fed does QE by exchanging a reserve deposit for a US Treasury security with the private sector. Clearly no net financial asset is created. Private sector had a US Treasury security asset, after the exchange it has a reserve deposit. 2) The US Treasury issues a Treasury security. Again, no net financial asset is created. Private sector had a deposit balance and exchanged it for a US Treasury security. 3) A bank lends thus simultaneously creating an asset (loan) and a liability (deposit). It's true a deposit has been created out of thin air. But what I think gets missed is that for the private sector, its net financial assets haven't increased. From a balance sheet equity perspective before the loan and after the loan, the net equity is the same for the private sector - so again, no net financial asset has been created. 4) The US Treasury spends. This (and only this transaction) creates a new net financial asset for the private sector. Just think of your net equity position right before and right after the stimmie check gets deposited into your deposit account. Clearly this transaction has increased your net financial assets. So from my perspective (which is the MMT perspective) - deficit spending by the US Treasury is the only one of these four transactions that creates a net new financial asset for the private sector. The net equity position of the private sector increases by the amount of US Treasury deficit spending. This is why the folks that focus on deposits (ie M2) get it wrong so often. They focus on the wrong thing. It's not the amount of deposits that counts - its the portion that is the direct result of US Treasury deficit spending. After that, the central govt sector (Fed + US Treasury) merely changes the composition of that new net financial asset by offering the private sector three forms in which to hold that new net financial asset (ie. currency in circulation, settlement reserves at the Fed, or US Treasury securities -- or as I like to call them in equivalent banking terms - a choice between cash, demand deposits, or time deposits). It is really conceptually very simple - but few really understand it and so a lot of confusion gets spread around. The final point is that a growing private sector economy needs more new, net financial assets from the central government (ie, deficit spending) - it is the natural order of things. But its a balancing act, too much leads to inflation, too little (or even running a surplus) leads to deflation. There I just summarized Kelton's poorly written book in one post. Bill