You seem to operate under the mistaken assumption that M2 and M3 are interchangeable with M1 and expanding one has the same inflationary results. That is not correct. Treasuries are long term debt that is very liquid and secure, but it's still traded long term debt . It's liquidity comes from the underlying assumption that a very small portion of the debt is traded in a given period, in other words that investors in treasuries don't make a "run on the bank". This guarantees a very small velocity of this pseudo-monetary base so it has very reduced bearing on the inflation (as I hope you agree, there is a direct proportionality between the price level and the velocity of money; if you don't I will be forced to withdraw from this debate).

You are saying that because this debt is traded, and you can always get close to 1 FRN dollar for 1 T-Bill dollar, then the two are functionally equivalent. To make an analogy, you are saying that if AAA mortgage-back securities traded very liquidly before the Lehman fall, then they were inflationary cash equivalents, in other words the private sector can expand the monetary base indefinitely. Well the cash equivalence of MBS stopped as soon as investors made a run on the market in a failed attempt to increase the velocity - the price dropped near zero. This is similar to what happened with Greece.

The point of the graph should be self explanatory: the bulk of the base money emitted by the Fed it's still with the Fed! Indeed, it was created by swapping long term debt for cash, but that long term debt has low velocity and it's not inflationary. The new base money would create massive inflation if it were to hit the market, yet the banks don't or can't do that.

Bottom line: the government does not create money when it issues debt; it can create debt up to a limit where the market will no longer deem it credible. Govt debt really is an appropriation of taxes from the future, a lease on society and the future generations, a proof of the current society's self-indulgence. The idea of financing deficits by printing money is a way to destroy the currency as a stable medium of exchange.