Digital Pound Seignorage Creates New Policy Space Financing

When the Fed undertakes Quantitative Easing QE , they expand their Balance Sheet BS when they buy High Quality Liquid Assets HQLA (+A) from banks, and increase their Liabilities (+L) when they issue new reserve account credits in the reserve account of the selling bank, which increases the total supply of reserves.

Fed BS:

+Assets (+HQLA)

+Liabilities (+reserves)

This is sometimes mocked by memes showing Powell using the Fed’s ‘money gun,’ and is generally seen as “printing money.” However, the bank is completing an Asset Swap, selling High Quality Liquid Assets HQLA (-Assets), and receiving new reserve account credits, aka ‘reserves’ (+Assets). This means there is not an increase in Assets for banks, no new assets in the banking system, only an increase in the liquidity of bank Assets.

Banks do not need reserves to make loans, so this increased liquidity results in no increase in loans or economic activity. And since the Fed sets rates using Interest On Reserve Balances IORB, the increase in bank liquidity has no effect on interest rates, although ample Ressrves can reduce the overnight rate that banks lend excess reserves to each other. So QE doesn’t seem to do much for banks in the current environment..

For the Treasury, they still have to pay Principal & Interest on the bond P&I regardless of who owns it. An interesting reality emerges when we look closely at bond repayment for bonds owned by the Fed.

When the Fed receives payment from the Treasury bonds they have purchased, they often or normally ‘reinvest’ the maturing principal by swapping out expiring bonds for new bonds, sometimes called ‘swapping paper.’ However, in some circumstances the Treasury has to complete payment to the Fed, so they sell new bonds and transfer those reserves to

When the Fed receives payment from the Treasury for bonds the Fed owns, this contracts the Fed’s BS.

Fed BS:

-Assets (-bonds)

-Liabilities (-reserves)

So the Fed owns $4T in UST bonds, but if they do nothing, the Treasury will pay $4T to the Fed and those reserves will be de-issued, and disappear forever.

There are only $3T reserves in circulation, so interestingly, the Fed would have to issue new reserves simply to assist the Treasury to pay off the bonds held by the Fed.

If the Treasury issued a new digital currency USTC to pay for their spending, then when they receive back in taxes that currency Liability would be de-issued..if tax receipts were less than expenditures, since the USTC was already spent, then the deficit would be funded by issuing new currency, not borrowing from the public by selling bonds, resulting in no new debt.

UST BS

+Liabilities (+USTC spending)

-Liabilities (-USTC tax receipts)

If we assume some people will hold their USTC and pay their taxes using their bank deposits, the UST will receive reserves from banks for those tax payments. The Treasury Liability for USTC will then circulate as currency, securing an interest free ‘float’ and digital currency Seignorage for the UST, until such time as the USTC comes back as tax receipts.

The UST spends $7T per year but taxes back $5T, borrows $2T, and there are $18T in deposits,

For every $1T in USTC issued that is not returned in tax receipts, that’s $1T in circulation in theory forever, new Seignorage that is neither borrowed at interest nor tax receipts, it’s issuance of new digital money,

The amount is unpredictable, but once issued, the amount of Seignorage should slowly build up.

The President or Congress could direct the Fed, as a matter of national security, to ‘lend’ $1T of UST bonds into an Infrastructure Trust. The UST will pay P&I on the bonds, building up $1T in reserves inside the Trust, which will ‘back’ the USTC.

The Trust will issue $1T in USTC, and any USTC returned in taxes will be de-issued, while the Reserves are untouched. Eventually new USTC can be issued to pay for critical new economic policy initiatives.

Launching a new USTC can secure new digital currency Seignorage, and provide new funding for new policy space to rebuild infrastructure that otherwise, will likely never get funded.

It’s not strictly issuing new money, because it ends up being backed by Reserves as the UST pays off the bonds. The trick is the Fed does not swap their expiring paper, and do not de-issue those reserves upon repayment from UST, instead they remain in the trust, and creates new money to spend with digital currency Seignorage.

The one major obstacle would be the Fed is fiercely independent, and will likely resist.

Therefore, this is more likely in England with the BoE, and could be used to fund new policy initiatives promoted by the Keen Institute.

What did I miss?

@Demetrios Gizelis

@Steve Keen

What say you?

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