Tuesday, March 13, 2012
QE and the lunacy of the gov't paying interest to itself
When the Fed conducts QE and expands its balance sheet by buying government securities, it receives interest paid on these securities. Last year it collected $80 bln, paid to it by the government (we, the people). Over the past four years it has collected over $400 bln in interest.
Then what happens?
The Fed turns that interest income over to the Treasury.
In other words, the government pays interest to the Fed, which the Fed then hands back over to the government. You got that?
This is just crazy. The government is paying interest to itself.
The Fed could just tear up those bonds, which it has no need for, and the debt would be reduced by $3 trillion in a single stroke. That’s how to reduce the debt. Too easy. That’s why we don’t do it. Instead, we continue this idiotic exercise of the government paying interest to itself and people worrying about the debt, which is clearly nonsense.
It’s like, if you took $1 out of your left pocket and put it into your right pocket, all day long and then saying all the dollars you put into your right pocket equated to a huge debt that was going to bankrupt you. However, if you just kept the dollar in your left pocket, you’re totally fine and solvent. Crazy stuff!
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25 comments:
Mike, perhaps the real lunacy is not the interest that is paid, but the principle being paid.
Basically, leaving the interest payments aside, that principle obligation consists in a commitment by the Fed to subtract a large quantity of money from the Treasury's account at the maturity date. Of course the Treasury then just borrows all or more of that same quantity back from the Fed in the same fiscal period. It sells bonds to private dealers which are then purchased by the Fed, in essence giving private middle men a cut of an intra-governmental operation for no good reason.
Yes, you're absolutely right, Dan. Sheer lunacy.
Look on the bright side.
Here in the UK, the Bank of England keeps the interest in a separate account and doesn't return it to HM Treasury.
Which means HM Treasury has to issue more Gilts - reversing the QE process over time.
At least the US process is consistent.
Yeah, Alexander Hamilton's 1790 "Report on Public Credit" should be mandatory reading. http://press-pubs.uchicago.edu/founders/documents/a1_8_2s5.html
The "national debt" is a political football from hell used to create "moral panic."
Give us Public-Purpose!
Give us Aggregate Demand!
LOL! I agree 100%, but could you imagine the headlines following the write-off of $3T in bonds,
"FED found to be insolvent after bad debt write-down. Hyper-inflation hours away!"
The only argument against “tearing up those bonds” is that if the central bank wants to reverse QE it then doesn’t have any bonds to sell. But of course the central bank can perfectly well just wade into the market and announce it wants to borrow at above the going rate of interest. That way it can mop up any amount of money it wants.
That might not be legal in some countries. But changing the law is just a technical matter.
The above borrowing by the CB is a bit of a temporary measure. If net financial assets (cash plus government debt) need to be PERMANENTLY removed from the private sector, that can only be done via increased taxes.
I have two comments. First, do they need those bonds to enable them to hit their overnight interest rate? And second, it does seem idiotic to call these bonds outstanding debt. At least in commercial accounting, if you buy your shares back and hold them they are not considered outstanding. So it is clearly foolish. If they are not needed, I agree, do not count them as debt or just burn them, if we can't get beyond that.
Jon,
Good analogy... its like if a company redeemed it's own bonds and put the certificates in a file cabinet, they would still consider them a long term liability, LOL....
Resp,
@ Jonf
1. Paying IOR equal to the target rate obviates the need to drain reserves to hit the target rate.
2. All money is "credit/debt."which implies that is someone's asset and someone else's liability. In the case of horizontal money, the liability is held by currency users, and so the relationship obligates repayment from revenue. In the case of vertical money, the liability is held by the currency issuer and revenue is not involved in meeting the obligation. The government's sole obligation is to accept the credits it issues at government payment offices. The obligations that are met at the payment offices are non-government liabilities that the government imposes in the form of taxes, fines and fees.
Failure it get this results in all sorts of ridiculous confusion through conflation of issuer and user, e.g., in the government as big household, for example.
Thanks Tom. I think I got the first one. So why do they need the bonds at all? Is there ever any need to drain those reserves?
On your second point, I am not sure I follow. It would seem they could just burn the bonds they are holding. Who would care?
Fed's been in there buying pretty strongly over the last few days (via quantity not price):
http://www.newyorkfed.org/markets/pomo/display/index.cfm?showmore=1&opertype=orig
They can't write off the debt.
How would they justify the spending cuts if they did?
Easier to pretend that one fine day all that debt will be sold back to the market and the budget constraint is real.
LOL! I agree 100%, but could you imagine the headlines following the write-off of $3T in bonds,
I don't think the Fed has the legal authority to just tear up T-bonds. Its like Congress set up a trust fund with the Fed governors as trustees who are tasked with paying the income from the corpus to the beneficiary, Tsy Since people only set up trust funds because they don't trust somebody, I don't think it was Congress's intention to allow the Fed to hand the corpus over to Tsy (that tearing up T-bonds is the same as handing over the corpus just shows how nuts it is that Uncle Sam actually borrows from anyone).
Tsy buying back the debt with platinum coins, on the other hand, is bulletproof.
@ Neil Wilson:
The Treasury is the Bank of England shareholder, and they share the BoE profits between themselves, apparently. The Treasury apparently gets somewhere between 25% - 50% of the profits.
The Bank of England Act of 1946 is a bit confusing however. It seems to indicate that those who held stock before the nationalisation might still receive interest (?).
"(b) the Treasury shall issue, to the person who immediately before the appointed day is registered in the books of the Bank as the holder of any Bank stock, the equivalent amount of stock created by the Treasury for the purpose (hereinafter referred to as the
“Government stock”).
(2) The Government stock shall bear interest at the rate of three per cent. per annum; and the equivalent amount of Government stock shall, in relation to any person, be taken to be such that the sum payable annually by way of interest thereon is equal to the average annual gross dividend declared during the period of twenty years immediately preceding the thirty-first day of March, nineteen hundred and forty-five, upon the amount of Bank stock of
which that person was the registered holder immediately before the appointed day.
(3) The Government stock may be redeemed at par by the Treasury on or at any time after the fifth day of April, nineteen hundred and sixty-six, after giving not less than three months’notice in the London Gazette of their intention to do so.
(4) After the appointed day, no dividends on Bank stock shall be declared but in lieu of any such dividends the Bank shall pay to the Treasury, on every fifth day of April and of October, a sum equal to 25 per cent of the Bank’s net profits for its previous financial year, or such other sum as the Treasury and the Bank may agree."
What a nutty situation. So riddle me this, why can't the Fed sell those bonds and turn the money over to the Treasury, who can then go out and spend it or whatever?
@ Jonf
Under the existing monetary system issuance of Treasuries is not operationally necessary, It is a politically imposed requirement that could be dispensed with if the cb used IOR for interest rate setting or just set the overnight rate to zero as Warren suggests.
Under the existing system the interest paid on Treasuries is a subsidy, hence, inefficient.
yes but then the treasury would still be paying the new owner of the bonds.
Tom, I read an article by Mosler recently in which he was apparently advocating raising the interest rate to provide more income to the economy...
beowulf
"Tsy buying back the debt with platinum coins, on the other hand, is bulletproof."
You would think so but as it is now the Constitution is just a piece of paper.
And not a very valuable one at that.
JJ: I read an article by Mosler recently in which he was apparently advocating raising the interest rate to provide more income to the economy...
Not familiar with that. Warren reiterated his preference for setting the target rate to zero at his place today.
@Pauli
I think the real problem is political. The heavens would collapse, if Obama issues a platinum coin for a trillion dollars to pay off the debt. Hell, there are any number of really bright people out there who think we need a balanced budget a la Europe. My neighbors on both sides would emerge with pitchforks and torches in hand.
Jonf
I agree that your perspective is more like what would happen in the real world. It would be political.
It just seems to me that the person-on-the-street could care less about Constitutional issues - they take it (whatever it is) for granted.
The only group that really cares is the lunatic fringe - and they tend to have a somewhat stylized view of what it means.
It's a dying document.
The FED targets the cost of money.
Bonds are a legally mandated way the FED serves this purpose via reserve drains. The same exact thing could be accomplished by IOR. It would remove the whole "national debt" football for both political parties to kick around.
Hey, can we get Mike Norman or Warren Mosler and Buddy Roemer in a room together?
He can lower the "debt," and the FED could still drain reserves. Win-win!
What say you, Mike?
Being right should count for something.
Give us MMT-Occupy!
"Tsy buying back the debt with platinum coins, on the other hand, is bulletproof."
I was wondering about this. Under current arrangements, doesn't the Treasury have to have credit in its account with the Fed before it can mint coins, and can only mint coins up to the value of the credit it already has in its account? The way the Treasury gets credit in its Fed account (under current arrangements is by taxing or 'borrowing'. Isn't this the case? If so then the Treasury can't create coins of any value it chooses..
JJ, beowulf pointed out a loophole inserted in the coin law. Do a search on "platinum coin" for extensive discussion.
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