With the emergence of interest-bearing money, the concept of ‘money supply’ is now meaningless. The obsolescence of interest-free money is not just a consequence of payment of interest on reserves by the Fed (as Steve Waldman argues). If short-tenor government bonds are liquid enough, then no one needs to hold non interest-bearing deposits for any meaningful length of time. For example, let us assume that rates are at 6%, the Fed has sold off all its QE holdings and is no longer paying interest on reserves. Therefore, bank deposits yield no interest. In such a scenario, most individuals can put most of their risk-free investments into an ETF or index fund invested in T-bills that pays say 5.80% (with 20 bps fees). In a world of such liquid risk-free investments, there is simply no need to hold cash except immediately before the need to make a payment arises.
The near-moneyness of governmentt bonds is not a new phenomenon. Preston Miller argued that this was already the case in 1983:
In the financial sector….higher interest rates make profitable the development of new financial instruments that make government bonds more like money. These instruments allow people to hold interest-bearing assets that are as risk-free and as useful in transactions as money is. In this way, the private sector effectively monetizes government debt that the Federal Reserve doesn’t, so the inflationary effects of higher deficit policies increase…..
In recent years in the United States there have developed, at money market mutual funds, demand deposit accounts that are backed by Treasury securities and, at banks, deep-discount insured certificates of deposit that are backed by Treasury securities, issued in denominations of as little as $250, and assured of purchase by a broker. In Brazil, which has run high deficits for years, Treasury bills have become very liquid: their average turnover is now less than two days.”
An institutional player doesn’t even have to sell his government bond holdings to access liquidity. He can simply repo his holdings instead. In fact the emergence of the government bond repo market in many emerging markets was driven by the private sector’s need to monetise its government bond holdings. Akçay et al illustrate how fiscal deficits led to inflation in Turkey despite the absence of monetisation because ”innovations in the form of new financial instruments are encouraged through high interest rates, and repos are typical examples of such innovations in chronic and high inflation countries. People are thus able to hold interest-bearing assets that are almost as liquid as money, and monetization is effectively done by the private financial sector instead of the government”.
Nevertheless, government bonds are only near-money and although financial institutions have easy low-cost access to them, the rest of us do not. In the remainder of this post, I will lay out how and why we can transform short-term government debt into not just near-money but money for the man on the street. This has significant benefits for every section of society and the government itself. The significant loser in this transition would be the incumbent oligopolistic players within our financial system, most notably the banks. This however is not a bug of the proposal, it is a feature.
Public Deposit and Payments Option
I have already described the essence of the public deposit option in an earlier post as “a system similar to the postal savings system where all deposits are necessarily backed by short-term treasury bills. If the current stock of T-bills is not sufficient to back the demand for such deposits, the Treasury should shift the maturity profile of its debt until the demand is met.”. The public deposit account should also include the ability to make payments (just like a normal bank account would).
Low-Cost Retail Access to Government Bonds
Government bonds must be as liquid and low-cost for retail investors to buy and sell as they are for financial institutions. The present options for retail investors to buy government bonds are not good enough. For example, TreasuryDirect requires you to transfer your bonds if you need to sell them. In the UK, the transaction costs (between 0.35% and 0.7%) are too high.
Reduced Funding Costs for the Government and Lower Public Debt
A large chunk of the present demand for long-term borrowing comes from the government(see this post for data). Unlike the private sector for whom the avoidance of refinancing risk is worth issuing long-term debt and paying up the liquidity premium, the government has no such need to indulge in long-term borrowing. The government can and should capture the safety premium that people are willing to pay for holding short-term risk-free deposits by shifting its financing to a shorter tenor. The United Kingdom is the best example of just how much governments can save by adopting this strategy. With the Bank of England owning as much as £375 bn of the national debt, the Treasury is in effect paying only 0.5% on this stock of debt. Many view this as an unwarranted monetisation of the public debt and argue that the profits being repatriated by the BoE to the Treasury will soon reverse themselves. But the Treasury could easily achieve the same economics as today by simply shifting its debt profile towards shorter-term funding. If it simply funded its entire debt by issuing bonds of less than 3-year tenor, it would fund at even less than the current BoE rate of 0.5%. There is no doubt that the appetite and demand to allow such a shift exists – the deposit base of the UK banking sector is far greater than £375 bn.
Safe Short-Term Deposits Without Deposit Insurance
In the system outlined above, there would be no deposit insurance i.e. all investments/deposits except for the “public option” will be explicitly risky and unprotected. The public benefits from a safe deposit, investment and payments option without the taxpayer being put on the hook for the costs of deposit insurance.
Improved Retail Investment Options
There is a significant retail demand for government bonds that is not being met at the moment. For example, Belgians lent €520 per resident to its own government when the Belgian government sold €5.7 bn of 5-year bonds at a rate significantly below the market rate in 2011. The reason was not patriotism but simply the fact that even this below-market risk-free rate represented a significant premium over the rates that ordinary Belgians could access through a risky bank savings account.
Firewall Between The Deposit/Payments System and Risky Banking
Rather than shackling incumbent risky banks, my proposal simply separates them from the risk-free depository and payments system.The public deposit option will also eliminate the rents currently being earned by the banks and shadow banking entities such as money-market mutual funds. The liquidity premium that is currently being captured by TBTF oligopolies will be captured by the state itself.
The obvious objection to this plan is: but what about maturity transformation? As I have shown in previous posts, the data is clear that modern economies no longer need maturity transformation. Household long-term savings (which includes pensions and life insurance) are more than sufficient to meet the long-term borrowing needs of the corporate and the household sector in both the United States and Europe.
My proposal does not nationalise our financial system. It simply extends the privileges enjoyed by financial institutions and corporates to the rest of us. Financial institutions and corporations have long enjoyed the benefits of interest-bearing money and the use of government debt as money. The first known instance may be the East India Company who could repo their government bond holdings for cash with the Bank of England (see footnote 20 in this paper). Unfortunately not much has changed between then and now. As is typical of the neo-liberal era, the classes demand an increased supply of interest-bearing safe assets for themselves while restricting the masses to putting their money in interest-free bank deposits.
Note: Parts of the above post have been rehashed from earlier posts and comments on Steve Waldman’s post linked above.