The Federal Reserve last week announced that it transferred $97.7 billion of its estimated 2015 net income to the US Treasury department, a new record. There are undoubtedly some people out there who see this as a great thing and wonder why we want to end the Federal Reserve System when the Fed gives the government so much money. You have to dig a little deeper and understand where that money is coming from to figure out what its effects are and why this is problematic.
The most important thing to remember is that this isn’t free money that is coming back to the Treasury. The Federal Reserve System does not receive any appropriated money from Congress. While the Fed makes some money by charging member banks for banking services such as check clearing, the overwhelming majority of the Fed’s income comes from the interest payments it receives on its holdings of Treasury securities. Due to the huge number of Treasury securities the Fed now holds from its quantitative easing (QE) policies, the Fed receives an extraordinary amount of interest. Once the Fed pays for salaries and other expenses, the excess income is turned over to the Treasury Department.
We also have to remember that the money to purchase the Fed’s bonds in the first place was created out of thin air. Let’s explain how much of the Fed’s purchases of Treasury bonds under quantitative easing took place.
- The federal government adopts an unbalanced budget that calls for more money being spent than being taken in.
- The Treasury Department sells new Treasury debt at auction to cover that budget shortfall.
- The new debt is purchased by Primary Dealers, other banks, foreign governments, etc.
- The Primary Dealers sell the new Treasury debt to the Federal Reserve.
- The Fed pays for those securities by creating new money from nothing.
- The Fed holds those Treasury securities and receives interest payments on them from the Treasury department.
At one point during the financial crisis, the Fed was purchasing Treasury debt within 30 minutes of it being issued. That might as well be direct monetization. The federal government got newly-created money to spend while the Fed got Treasuries to hold as assets and interest payments to pay for its operations, while the banking system was the conduit through which this shell game was played. While most of the new money created through QE remains tied up in excess reserves at the Fed, much of it did still get out into the economy, inflating the money supply and leading to rising prices.
Another problem is that Congress might see these huge surpluses and think of the Fed as a source of new money to tap into to pay for more pork barrel spending. That already happened late last year with the passage of the FORM Act and the transfer of over $19.3 billion of the Federal Reserve Banks’ surplus to the Treasury to pay for highway spending. But these excess profits received from the Federal Reserve are already budgeted as an incoming receipt in the federal budget, so this isn’t money that was unexpected. We would hope that Congress would recognize that, but you never know.
There’s also the fact that one of the Fed’s expenses is paying interest on excess reserves held at the Fed. If those costs rise faster than the interest on the Fed’s Treasury holdings, then the Fed will have less money to turn over to Treasury, which could upset federal budget projections. That’s not something that can be forecast with any great accuracy as it is highly dependent on the Fed’s federal funds rate target, the level of which cannot be forecast with any accuracy even by the members of the Federal Open Market Committee who are responsible for setting that target.
The long and the short of it is that these large transfers to the Treasury Department are indicative of a highly irregular monetary policy that has monetized a huge amount of government debt. These transfers should not be celebrated or accepted as a normal occurrence. Rather, the goal of policymakers should be to get these transfers as low as possible. The ideal, obviously, should be zero, as monetization of government debt is never a good thing. The more easily it is accepted now, the more easily it will be accepted in the future, and a Weimar-style hyperinflation in the United States would be catastrophic. No matter how earnestly the Fed may believe it, you cannot print your way to prosperity.