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At first I thought a recent Washington Post article regarding 'earnings' at the Federal Reserve was a joke. But it appeared in the business section, and there weren't any "gotcha!" retractions the next day, so I assume it was meant to be serious.
For those who understand the very simple idea that the Federal Reserve prints Federal Reserve Notes (or their electronic equivalent) out of thin air, the concept of 'earnings' on those same thin-air money units is intellectually challenging.
Here's the article:
Federal Reserve earned $45 billion in 2009
Wall Street firms aren't the only banks that had a banner year. The Federal Reserve made record profits in 2009, as its unconventional efforts to prop up the economy created a windfall for the government.
The Fed will return about $45 billion to the U.S. Treasury for 2009, according to calculations by The Washington Post based on public documents. That reflects the highest earnings in the 96-year history of the central bank. The Fed, unlike most government agencies, funds itself from its own operations and returns its profits to the Treasury.
The numbers are good news for the federal budget and a sign that the Fed has been successful, at least so far, in protecting taxpayers as it intervenes in the economy -- though there remains a risk of significant losses in the future if the Fed sells some of its investments or loses money on its stakes in bailed-out firms.
First of all, the word 'earnings' implies that value was created and/or something was at risk. Neither applies to the Fed. Let's review the process by which they 'earned' money in 2009. We'll simplify this by examining just one of their activities, the purchase of Treasury debt.
Step 1: Using keystrokes, create $300 billion out of thin air.
Step 2: Buy Treasury notes and bonds with the $300 billion.
Step 3: Collect interest from the US government on those notes and bonds.
Step 4: Report record 'earnings.'
Step 5: Wash, rinse, repeat.
What is the meaning of 'earnings' in that series of steps? What value was created? Where was the risk? In this context, the word 'earnings' has no meaning or any relevance at all. It's the exact same thing as if the Fed had printed 46 billion dollars put them on the income statement and called them 'earnings.' Or 10 trillion dollars. Or one dollar. When you can create any number you wish using a keyboard, the number itself is meaningless.
Further, we might wonder about the comfy relationship between the government and the Federal Reserve in which the Fed buys government debt, the government then pays interest to the Fed on that debt, and the Fed then (mostly) returns these interest payments to the government as "excess profits."
In that little circle, the Fed reports profits and the government reports revenue from the Fed. They both 'win!' But the entire thing is really just a sleight-of-hand exercise, wherein the Fed prints money out of thin air and hands it to the government.
It's a crafty little game with lots of moving pieces, but the essence of it is that money was brought into existence without any corresponding goods and services being created. Which means that it is not a good thing (as reported); it is actually a bad thing. It is among the most inflationary and dangerous monetary activities that can be performed, at least if the past 800 years of monetary history is any guide. It looks clever and sounds sophisticated, but it really is nothing more than a distributed tax on every outstanding dollar in the system. If the founding fathers despised taxation without representation, they would have truly hated this shell game.
Second of all, I reject the entire premise of the WaPo article, in that it promotes the notion that the Federal Reserve operates like any other normal business with a profit & loss (P&L) statement that in some way provides us with meaningful information.
The simple truth is that the Federal Reserve creates money out of thin air for the purpose of buying debt instruments. That's it. That's its entire business model. Sometimes those debt instruments are US Treasury bills, notes, and/or bonds and at other times (like in 2009), they are mortgage backed securities, destroyed CDS and CDO paper from Bear Stearns, GSE agency debt, and so forth.
The Fed business model is this: Thin-air money is created and exchanged for debt.
If any other company could perform such an operation, then it might be useful to compare their relative performances, meaning that a P&L analysis could provide some insight. But given that only the Fed has the power to manufacture new money from thin air, the P&L is nearly meaningless (and it is utterly useless without a corresponding audit and 'mark-to-market' accounting rules).
Since we have no idea to what extent the Fed is sitting on massive losses, or even what they are sitting on in many cases, the concept of P&L 'earnings' are as completely irrelevant as anything can possibly be. Thus, promotion of the idea of Fed 'earnings' is not just erroneous, it's misleading.
Here's another gem from the article that captures the essence of my point:
"This shows that central banking is a great business to be in, especially in a crisis," said Vincent Reinhart, a resident scholar at the American Enterprise Institute and a former Fed official. "You buy assets that have a nice yield, and your cost of funds is very low. The difference is profit."
"...your cost of funds is very low." That part made me smile. It's like me saying that the cost of using a calculator to multiply by a higher number vs. a lower number "is very low." Yes, pushing buttons is a low-cost adventure.
A central bank is not a business; it is a government-enforced cartel with the unique ability to create money out of thin air. This is not a trivial distinction, and we would do well to view a central bank's activities through a different lens than we use to view the rest of the productive world.
Instead, we would be best served by paying close attention to what the most powerful cartel is up to, as their private missteps become our collective pain. This is why I completely support the idea of having the Fed audited by an independent third party, just like any other public business.
If the Fed continues to refuse to submit to an audit, then I would support the establishment of a competing entity to the Fed that could also issue its own government backed currency. Then the marketplace (you and I) could decide for ourselves which unit of currency we'd prefer, using whatever information and data each would be willing to provide. One thing that nature has taught me is that competition makes for a stronger and more resilient organism.
Without any accountability, and with a complete monopoly, the Fed has grown weak and lazy, as evidenced by its horrible, serial-bubble-blowing performance over the past two decades and its apparent inability to differentiate between asset inflation and wealth. It is either time to enforce complete transparency, or, preferably, create some legitimate marketplace competition.
So that's it: Let's have an audit with publicly available results, or let's have some competition.
Or maybe even both?
- cmartenson's blog
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So if the Federal reserve can print money out of thin air and use it to directly buy non-US Treasury debt instruments, then it is possible for money to be created that is not backed by debt?
Say the Fed prints a million dollars and buys some morgage backed securities for that sum. While the Fed holds them the value goes down to 1/2. The Fed then sells them back into the market at the 1/2 million dollar price. Isn't then the other 1/2 million created with no debt backing at all?
I saw this same article and winced when I read it too! How can any journalist, much less news organization print this without asking the simple question "why does the Fed earn a profit, and why should it earn a profit?" Chris your articles are always spot on and I tend to agree with most every point of view you make. One thing I would however like to see is more cheerleading for the very very few (or one politician) who is trying to make a difference and has the same view (aka Ron Paul) A grass roots organization such as CM needs to rally it's members and point them towards political leaders who have the same sentiment and determination to do the right thing. Only through this cross-networking will the voice of thousands turn into tens of thousands and then hundreds of thousands and on...
Keep up the great work!
Isn't this similar to what got Qwest into trouble and indirectly led Nacchio to prison. (As a former Qwest employee whose employee stock purchase program was a complete loss, at least some justice.)
''Assuming the swaps of capacity had some business justification, I did not understand why they weren't simply accounted for as like-kind exchanges of assets,'' Mr. Olofson told the committee. Instead, the exchanges were often booked as revenue for both parties, either upfront or over the life of the contract.
http://www.nytimes.com/2002/09/25/business/internal-notes-questioned-qwest-s-swaps.html?pagewanted=1
Unfortunately, the likelihood of Ben joining Joe in prison is nil, since the government is a participant in the scheme.
Chris,
What they should be saying is that the undisclosed assets purchased by the Fed with thin air TARP money removed $45 billion in payments and realized capital gains from the market, reducing the taxpayer burden of TARP by $45 billion (this if the Treasury had used the $45 billion to pay down our national debt {which they didnt}).
So acquiring the assets "cost" (or "required the fed to distribute") $700 billion INTO the market. But by holding the assets for a year (and selling some hopefully) the Fed reclaimed $45 billion FROM the market.
What they decide to do with this $45 billion is another question.
Already a bill for introducting competition, of course from Ron Paul, it's HR4248.
Great report, Chris. I have an inquiry for you and other folks that perhaps you can help with.
In spreading the gospel, I have using an analogy to explain to non-believers (and understand it myself) what the Fed is doing, how the Fed is doing it and what final outcome would look like. Here goes....
Let's say you are playing a game of Monopoly with all the rules intact except you add the following rules:
1) The banker can print on demand as much as the banker wants and dole it out as the banker sees fit.
2) The banker is paid interest (say to make the math easy 1%) on the total amount of printed money each time a player passes "Go".
3) The banker can loan anyone any amount of money to stay in the game. Each player must pay what ever interest is agreed upon each time they pass "Go".
4) The government gets paid 30% on the profit a player makes each time they pass "Go".
Is this a too simplistic version of what is going on with the Fed, the government and our economy? What other "rules" would you add?
How would the game play out? What would be the strategy?
Let's say you hoard your initial cash, buy a low value property like Baltic Ave, load it up with houses and hotels then wait for some out the dice. Then, pray that somebody lands on your space, hope you dont land on Broadwalk where another player is using the same strategy and you stay in jail as much as possible. Eventually, you are going to land on Broadwalk, get a loan to keep going and pay the banker - so the cycle repeats over and over again until what happens?
Why even play the game? The banker cant lose - unless everyone quits the game. The government can't lose - unless everyone quits the game.
Let say eveyone played this game indefinitely. What is the end game? Who will be the last one standing? Who is the winner? Is the winner the one who is in possession of all the assets?
It seems the only way to win is to either be a banker, be the government, go to jail forever or quit the game.
Why go through these shenanigans to create debt-free money? The government could create its own money debt free. There is no reason for the Federal Reserve to create money and loan it to the government and then earn interest from it. This is absurd. If the government created debt-free money then there would be no national debt. Of course, the same issues with inflation exist but at least the whole country (and world) is not in debt to the private banking system. These ideas have at least been put before the House (granted, to a virtually empty chamber) through Rep. Dennis Kucinech through the work at the American Monetary Institue (www.monetary.org).
Debt-based money creation is clearly at the root of the country's problems.
Jeez, thanks Chris. I read that article and I was thinking it was a bunch of hooey. I kept going, "Wait, the Fed conjures up money, buys treasuries, profits on the interest, and gives the interest back? (theoretically)". Huh?
Now, is the reason for all this craziness that the government can't print money out of thin air directly, and they use this scheme to get around it?
Has anyone had a chance to see Mish's article on the St. Louis Fed's latest paper?
Read MISH's article here: http://globaleconomicanalysis.blogspot.c...
Then read the St. Louis Fed paper here: http://research.stlouisfed.org/wp/2010/2...
The title of the paper is: On The Social Cost of Transparency in Monetary Economies - I'm not kidding
As if that wasn't flagrant enough, we can see there are calculus equations in the paper describing the value of making decisions at night while the consumer is asleep. This article reminds me very clearly of O.J. Simpson's If I Did It. I've read parts of that book before it was "unreleased" and I can tell you I am certain that he murdered Nicole, as if I wasn't already. If this type of paper does not convince us that the FED is engaging in a lot of surreptitious activity ("for our good" of course) then I don't know what will.
If the FED is indeed acting as an agent on my (our) behalf as a taxpayer, then I want accountability. Oh, that's right, the FED doesn't need my taxes to fund itself...then what motivation does it have to act as my agent???
My blood is boiling.
-formerly StudentOfJefferson, reporting live from the Washington D.C. Metro Area
Superb post Dr. M,
I love the idea of a competing currency. Can you expand on how you think it might actually be implemented?
Captain Sheeple