Monday, February 6, 2012

The US Federal Reserve Really Does Turn Over Profits to the Treasury

It is repeatedly stated by bloggers and others self-published on the Internet that the US Federal Reserve is a scam because it prints money for the US Government and then charges the US Treasury interest on the money thus conjured out of thin air.

In fact, charging interest on money created out of thin air is what commercial banks do. They create credit in amounts many times what has been placed on deposit with them and charge borrowers for the use of the money thus created.

The Fed, however, operates differently. If the Treasury needs money, it prints off some bonds and hands them over to the Fed, which then writes the Treasury a check for money it does not have -- so-called ink money.

The Treasury then spends the money the Fed just created out of thin air, while paying interest at the rate specified by the bonds held in the Fed's portfolio.

However, at the end of the year, the Fed pays the Treasury its profits, i.e., interest earned on the Government paper it holds less operating expenses.

So all that actually happens is that the Government pays itself interest on money created for it by the Fed, less the cost of the Fed's role as an intermediary.

Why, one might ask, involve the Fed at all?

The answer is that by handling the Government's paper, the Fed can control the money supply by selling bonds to the public, or buying them back.

When the Fed sells bonds it takes money out of circulation and reduces the money supply. When the Fed buys bonds either from the Government or the public it increases the money in circulation.

The money that the Fed receives on the sale of bonds to the public goes out of existence as magically as the ink money with which it purchased the bonds was conjured into existence.

The only significant consequence for the Treasury of Fed bond sales is that the interest on the bonds is no longer returned, courtesy of the Fed. It is at this point that the interest on the money created by the Fed becomes a real expense to the Treasury and thus to the American taxpayer.

This is as it should be, since the money with which the bonds have been purchased by private parties is real money, not funny money, which is to say that by purchasing government bonds, investors are giving up use of their money and expect, naturally, to earn interest in return.

Confirming that the Fed does not earn interest beyond its expense of operation on bonds that it purchases from the Treasury, the New York Times states in an article published today:
The Federal Reserve said on Tuesday that it contributed $76.9 billion in profits to the Treasury Department last year, slightly less than its record 2010 transfer but much more than in any other previous year.

The Fed is required by law to turn over its profits to the Treasury each year, a highly lucrative byproduct of the central bank’s continuing campaign to stimulate economic growth.

Almost 97 percent of the Fed’s income was generated by interest payments on its investment portfolio, including $2.5 trillion in Treasury securities and mortgage-backed securities, which it has amassed in an effort to decrease borrowing costs for businesses and consumers by reducing long-term interest rates.
So if any cranks or crackpots out there still wish to maintain that the Fed prints money and pockets the interest on it, I say take it up with the New York Times, and don't waste your time arguing the point here.

None of which is intended to suggest that the Fed is an unmitigated blessing on the American people or that it should not be audited. On the contrary, it is impossible to judge the value of the Fed without knowing what it does, and anyone who opposes a thorough review of the Fed's activities is probably a banker whose owes their job and bonuses to the generosity of the Fed to undeserving speculators and fraudsters.

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    1. Since the passage of the Federal Reserve Act in 1913. See text here.

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