The Fed creates Money. Currency is created by the Treasury Dept.
I prefer to use the term “cash” for Treasury bills and coins, as I explained before. Currency is a medium of exchange issued by a government. Cash is made available to meet consumer demand, usually fluctuating seasonally, but it is not created “on top of” existing currency at the Fed. The Fed member banks exchange currency from reserves for it without increasing the overall money supply.
When the Fed buys a bond they create money, the price the Fed pays for that bond ends up in a bank account as dollars.
A bond, like taxes, destroys money, only temporarily. The Fed shares a balance sheet with Treasury, so the money the Fed creates to purchase a bond is zeroed out by Treasury’s debt, making the purchase a no-cost exchange. This allows the Fed to purchase an unlimited amount of bonds to set interest rates on the secondary market. Any money the Fed creates above what Congress authorizes to be spent disappears when the balance sheet is reported at the end of the fiscal year along with any profit the Fed might realize.
Bonds are only issued as the Treasury’s spending account is depleted, so spending “funds” bond purchases, not the other way around. The more the government spends in deficit the more excess reserves are looking for secure parking with interest dividends, which drives bond prices downward. The Fed can only drive interest upward by removing bonds from the market and offering its target rate for them. It lowers interest by simply doing nothing and letting market forces determine price. The natural rate for bonds in a sovereign fiat currency market is the smallest increment above zero.
Bonds are not, and never have been, a “funding” mechanism for Treasury. They only allowed Congress to anticipate taxes to spend above the value of the gold reserve when we did that nonsense. With a fiat currency there is no revenue or spending restraint on Congress, so bonds are totally unnecessary except to regulate interest upward and to offer a floor for investor yields.
About $5.9 trillion of that debt is held by other government agencies like the Social Security Trust fund and the Military Pension Plans.
This is where misunderstanding of bonds does real harm. The government can never “hold” our money for us. It can only use that money to reduce the debt and promise to create new currency, and debt, as the bonds mature. FDR created the Social Security trust fund and the FICA tax to give beneficiaries of the program a legal claim to their benefits. He fully knew the hatred the Republicans would have for the program in the future, but I don’t think he envisioned that they would ever limit benefits to the payout of the fund, or that Democrats would be so timid as to not assure the fund was sufficient to allow workers to retire in dignity.
The extremely regressive FICA tax does nothing to enable Congress to pay out benefits. Any macroeconomic argument for storing productivity to be used later by the workers when they were no longer productive went out the window when jobs began going overseas. If Americans are too stupid to defend their own best interests we should at least allow them the full benefit of their productivity while they are working and let them deal with their retirement benefits politically without the false promise that their money is being held for them and gaining interest. As much as Republicans hate Social Security, its demise will be their own as well.
