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While the sovereign does not need to issue bonds in order to fund deficit spending (because the sovereign, being able to enforce legal tender laws, does not need to fund deficit spending at all), it can sometimes be a good idea to issue bonds in a volume that happens to coincide with the amount of deficit spending.

Imagine that you are deficit spending because you are in a balance sheet recession. The fact that you are in a balance sheet recession means that a lot of the legal tender you deficit spend is going to end up in somebody's mattress, to offer collateral against potential margin calls.

This is not really a problem - after all, you can just deficit spend more. But what happens when you have lifted the economy out of depression? Why, all the legal tender that was hidden in mattresses to guard against margin calls that never did come (partly because you were deficit spending to get the economy afloat again) is going to come out of those mattresses.

This is why you want to, during the recession, exchange some of the legal tender in the mattresses for T-bonds. For the purpose of guarding against margin calls, T-bonds are very nearly as good as legal tender, so you do not impose any great drain on any actual cash flow. But when the mattress-stuffing people discover that the recession is over and attempt to take their money out of their mattresses, they will find that when it comes to doing anything other than covering your ass from a margin call, T-bonds are considerably less useful than legal tender.

So by issuing T-bonds during your deficit spending, you can obtain greater control of the process of returning the money stuffed in mattresses into the political economy.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Sat Oct 9th, 2010 at 09:31:43 AM EST
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