Wikinvest Wire

Why the Fed wants to issue its own debt

Wednesday, December 10, 2008

One of the great mysteries of our debt-fueled financial system in general and central banking in particular is exactly when it is that "money is printed", a phrase that is thrown around quite casually by far too many people when maybe it shouldn't be.

Our fractional reserve banking system effectively "prints money" each time a new loan is made. That much should be clear. With a ten percent bank reserve ratio, each new $1,000 in deposits can generate $10,000 in loans. Where does this extra money come from? It is created "out of thin air". That's the way banks work.

Up until late-2007, Wall Street's "shadow banking system" did something similar, however, it apparently had what amounted to a zero percent reserve ratio which is one of the major reasons that we have the crisis that we have today.

As for the U.S. government, "printing money" is performed by the Federal Reserve when it buys Treasury bills (or any other assets of questionable quality) and in return provides money that it creates "out of thin air".

This is generally frowned upon for obvious reasons.

Largely as a result of the willingness of our Asian trading partners to do so, the Fed has not needed to buy much U.S. debt in recent years, its balance sheet remaining fairly constant at around $800-$900 billion up until a few months ago when Lehman Brothers was allowed to fail and the downward spiral commenced.

As most everybody knows, the Fed's balance sheet is now almost $1.5 trillion bigger, prompting the question of where exactly this $1.5 trillion came from.

Well, some of it came from the Treasury Department but, as discussed last week, a good portion of this was simply "created out of thin air" and then exchanged with companies like AIG for one toxic asset or another.

It is all adding up very quickly and, with no end in sight for the current crisis, it should come as no surprise that the central bank is looking for ways to get even more money into the system without people all around the world wondering about where all the money is coming from.

According to this report in today's Wall Street Journal, it seems the Fed is now looking at issuing its own debt in order to bypass that cumbersome Congressional approval process for issuing Treasuries.

The Federal Reserve is considering issuing its own debt for the first time, a move that would give the central bank additional flexibility as it tries to stabilize rocky financial markets.

Government debt issuance is largely the province of the Treasury Department, and the Fed already can print as much money as it wants. But as the credit crisis drags on and the economy suffers from recession, Fed officials are looking broadly for new financial tools.

Fed officials have approached Congress about the concept, which could include issuing bills or some other form of debt, according to people familiar with the matter.

It isn't known whether these preliminary discussions will result in a formal proposal or Fed action. One hurdle: The Federal Reserve Act doesn't explicitly permit the Fed to issue notes beyond currency.

Just exploring the idea underscores many challenges the ongoing problems are creating for the Fed, as well as the lengths to which the central bank is going to come up with new ideas.
As Andre Agassi used to say, "Image is everything".

Why look bad when the rest of the world remains scared to death of global financial markets, more than willing to continue gobbling up U.S. debt at ridiculously low yields, and your only real problem is that your government can't authorize enough spending fast enough?


hardwinterwheat said...

this leaves me nearly speechless ... when does it end ?!?

Karl M. said...

It ends with a deflationary depression, but not until we get hyper-inflationary bust.

John M said...

Hi Tim,

Maybe it's time to worry about that late 1968 "Credit River Decision" thingie ;-)

But seriously, besides contriving to have lots of pretend wealth stick to the fingers of erstwhile particle physicists, what was the point in having a fiat currency system based on Feynman Diagrams in the first place?

Anonymous said...

Karl. M.
I really agree with you, and there is a huge flow of thinking around this ideas.
They know exactly what are they doing, even if they are supossed to be making a counter attack on imaginary deflacion, in fact they are trying to not to lose the control of assets and goods, until the party starts. After that, just thinking about a depression is not accurate. After such a worldwide party, wars and riots are very likely to happen, so that it would be necessary to add war economics (rearming to face potential or effective threats).

Que dios nos ayude y salvese quien pueda, seƱores.

Tim said...

1968 Credit River Decision and Feynman Diagrams...I learned two new things today.

joshua said...

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Lisa said...

Since Federal Reserve enjoys and can command more trust among the masses, is the reason for debt instruments decisions. Can this be the reason? More money will flow to Federal Reserve and they will inject it to revive the markets. It would be interesting to watch on these developments.

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