How low can the Fed go?

Jerry Mazza
Online Journal
Friday, Dec 12, 2008

According to the Wall Street Journal, Federal Reserve officials have approached Congress about a debt sale of its own, including the issue of bills or some other form of debt. At this point, no one knows whether these feelers will produce a formal pitch or Fed action. The only rub is: The Federal Reserve Act doesn’t explicitly permit the Fed to issue notes beyond currency. And that’s too much already.

But, the Fed is faced with a $25 billion drain in temporary reserves from the banking system when it organized overnight reverse repurchase agreements. And to further lower spirits, the Fed’s balance sheet has zoomed from under $900 billion to more than $2 trillion since August, as it propped up new markets like commercial paper, money-market funds, mortgage-backed securities and ailing companies, such as the infamous American International Group (AIG).

The inflating balance sheet is making life hard for the Fed. In the early phases of the present mayhem, Fed officials funded their programs as they drew down holdings of Treasury bonds. They used the proceeds to finance new programs. But officials don’t want the backroom pile to get too low — like your savings account, credit rating, Social Security, or my bond portfolio. The Fed nut is now at $476 billion, with a chunk of it committed to other programs. The Fed has actually asked the Treasury Department for cash. Bernanke offered to go out in the street with his hat in hand.

Fortunately, the Treasury responded by issuing debt, leaving on deposit the proceeds with the Fed for it to use as it sees fit. But as bailout-o-mania continues, Treasury is pulling back on the Fed offer. Treasury has its own humongous borrowing program to digest and it faces, believe it or not, legal limits on how much it can borrow. But the Fed has recently started funding its programs by chewing through the financial system money it created, euphemistically known in central-banking circles as bank reserves. The Fed also used its money to make loans and buy up assets.

(ARTICLE CONTINUES BELOW)

Wasn’t that what the Fed was explicitly created not to do: add another currency?

• A d v e r t i s e m e n t

Some economists take issue with the outcomes of this approach. Fed officials could find themselves in a pickle to rake in the money from the system once markets stabilize and the economy gets better. Don’t hold your breath. So far it’s not “a problem,” but it could be later and cause inflation if they don’t act soon. Even the fed-funds rate for overnight borrowing between banks has fallen below the Fed’s 1 percent target. It’s supposed to reduce that level next week. So, once more, how low can the Fed go?

The WSJ reports that “Louis Crandall, an economist with Wrightson ICAP LLC, a Wall Street money-market broker, says the Fed’s interventions also have the potential to clog up the balance sheets of banks, its main intermediaries” He adds, “Finding alternative funding vehicles that bypass the banking system would be a more effective way to support the US credit system.” The question is could Fed-issued bonds create new problems, like devaluating Treasury paper as it issues tons of debt itself. And golly what will it do to our money, like drive its value into the ground.

You’ll have Fed bills out there selling with Treasury debt. Well, there’s nothing like competition and free enterprise, right? Wrong. With T-bill rates nearly at zero, Fed debt shouldn’t push Treasury rates higher, though one day it might become a problem. Additionally, there are real questions about whether or not the Fed has the authority to even do this. This is what one of the problems that comes with turning your country’s money over to a private company. See my recent Bag the Fed!

In fact, since the Fed wants to go its own way with its own debt, maybe the time for separation and divorce has come. Even a former Fed senior staffer, Vincent Reinhart, commented, “I had always worked under the assumption that the Federal Reserve couldn’t issue debt.” He feels it’s an action more appropriately suited for the Treasury Department, which has clear congressional authority to borrow on behalf of the government. Well, I would suggest this might be a good time for Congress to consider rescinding that power and letting the Treasury stand on its own two wobbly legs.

This could be a start towards avoiding a central bank system that from the very start loaned the federal government two million dollars to issue 10 million in currency, the balance raised from people in America and Europe. Unfortunately, it left the newborn dollar with an inherited addiction to debt. What the Fed is about to do will only worsen the pain.

So why not cut the cord? Or nationalize a new kind of transparent, non-secretive Fed into an equally transparent Treasury. Hopefully, in the long run we could eliminate debt as an exponentially expanding constant, like some kind of hump on the back of our economy. Imagine that. To stand up straight and walk like a healthy people again, a new high for us. Do I hear Andrew Jackson crying, yes, yes, from the beyond?

Print this page.

Comment Rules

Comments are closed.