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Government Bonds

Government Bonds

There are two “independent” governmental financial institutions, the Central Bank and the Treasury. The CB has the official right to issue money. Formally, the Treasury has no money right to issue money and is designed to collect appropriate taxes to provide for government’s expenses. However, in reality the Treasury both uses tax profits and accumulates money through issuance of government bonds. Therefore, the national economy sells goods and services to the Treasury in exchange for its debentures.

What are the debentures by their nature? Can they be compared to physical or legal entities’ debts? Can the government, just as a private company, declare default due to lack of money?

As you remember, modern money by its nature is nothing but “debts” of one of the government agencies, the Central Bank. This word “debt” is quoted here because in reality, the CB does not have to pay anything to discharge its obligations. And may the fact that one governmental agency is responsible for issuing money lead to another government agency’s lack of money at some point?

It is as if you (the Treasury) had an opportunity to pay with IOUs, and when the payment date comes, pay with IOUs of your spouse (the CB) that are, in turn, irredeemable.

A healthy state with responsible legislative and executive powers simply cannot declare default on its own obligations. If it does, it means that the political crisis within the state has become so bad that the state no longer exists. But of course, the situation would be different if the Treasury borrows funds in foreign currency that the national government cannot issue (for example, if a developing country issues bonds in US dollars). In this situation, the national CB can only help if it has sufficient reserves of that currency. If the reserves are insufficient, the government may declare default.

Treasury bonds are part of money stock that are so reliable that in some cases, investors are willing to buy them even if they have a negative rate of return—that is, pay more for them than will be paid back when the bond is redeemed. Investors know that if the CB may at some point refuse to support a commercial bank, it is highly unlikely to refuse to help the Treasury.

How is this help provided?

If the Treasury has no sufficient money to pay its debts or make other current payments, the CB can buy the Treasury’s bonds by remitting cash on its account. The accounts will look as follows:

Due from Treasury Account of Treasury in CB

100 units

100 units

Then the Treasury has the ability to make ordinary cashless payments from its account in favor of any entities, therefore injecting the created money into the economy:

Due from Treasury Account of Treasury in CB

100 units

Opening 100 units

Payment to banks

            -30 units

Account of Treasury in CB

Closing 70 units

Accounts of banks

                               30 units

Moreover, the Treasury now does not have to worry about paying its debts that are on the CB’s books—the debt repayment period can be extended as much as it likes, based on the government’s needs because these are debts within one single family. This means that if those bonds are declared legally irredeemable, nothing will really change. Money created by the Central Bank by buying the Treasury’s irredeemable bonds will represent the cleanest and most honest option of money emission. Why so?

Here, a very interesting and important question arises!

What do you think the Treasury recognizes in return for its issued bonds?

What does the Treasury write in its books against the money it created? What assets does it show on the left-hand side of its balance sheet? The answer to this is very demonstrative of the nature of money. Look at an excerpt from The Department of Treasury’s 2012 annual Agency Financial Report:

General Fund liabilities, primarily federal debt, are obligations of the U.S. Government that have accumulated since the U.S. Government’s inception. These Department-managed liabilities are separately reported on the Consolidated Balance Sheets, with a corresponding amount reported as Due from the General Fund. Due from the General Fund represents a receivable, or future funds required of the General Fund to repay borrowings from the public and other federal agencies.

Using our illustration technique, this statement can be shown as follows:

Due from The General Fund Debt of US Government

$ 16 trillion

$ 16 trillion

 

“Due from The General Fund” is nothing but the debt of the entire economy, the entire society to the government—this is the most dramatic example of the nature of money as a social institution. This excerpt from the Treasury statement shows that legitimacy of money is supported by the entire society and serves as a strong argument that money emission and circulation must be transparent and controlled by people.

Using this information, let us now look at what the money on the bank account ultimately looks like:

Cash in vault of your bank Bank account

100 units

100 units

Through the agency of the CB, this money represents due from the Treasury:

Debt of US Government Cash issued

100 units

100 units

 

And, finally, it comes back to the society that owes the Treasury:

Due from the General Fund Debt of US Government

100 units

100 units

 

“Due from The General Fund” is the most real money: it represents direct claims on the entire society, to all of us. Strictly speaking “Due from The General Fund” is not a debt, but the concept – the name of the institution – that legitimates the government bonds and the Central Bank’s money as national currency. As long as people are united, share common beliefs, and trust each other, the society is strong enough for the claims on it—i.e., its money—to be valuable to everyone. This is the only source of financial stability.

Defining money as a social institution we can analyze the European crisis from the fresh point of view. As the currency of the Eurozone derives its strength from different nations with different societies and economies, it does not have proper support from any of them. The Eurozone is a monetary union without banking and fiscal unity that means that there are three completely different types of Euro: 1) really single currency – liabilities of the European CB, 2) debts of governments of the Eurozone members, and 3) accounts at banks of the different Eurozone countries. If you have one dollar in your wallet or an account in any US bank or you hold US Treasury bills, you believe that you have the same currency of the United States of America. But your investments in Greek and the Netherland’s government bonds are completely different exposures to the Eurozone. Your money on your accounts in a German or a Cyprus bank is not the same currency although both accounts are nominated in euro. The European Central Bank as a creditor in the last resort does not have a unified approach to support all the Eurozone’s governments and banks because the population of the Eurozone is not the united society. The conflicting nations cannot support a common currency. To solve the issue the Eurozone countries should either divorce or become the real family.

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