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The Danger behind the Fed's Exceptional Profits
Thus, the so-called "profits" are NOT evidence that the US economy is doing well. Far from it, these profits are proof that the printers are working long hours. Moreover, the state's Dept. of Moral Hazard has taken upon itself Robert Wadlow-sized liabilities, which call into question the solvency of the entire American financial system.
The Danger behind the Fed's Exceptional Profits
A few days ago, the Fed announced that it had "earned" a record-high
amount of money in 2009. Then it turned $46 billion over to the
Treasury. Here we are in the midst of a serious recession, with the
unemployment rate high, the housing market still in a slump, and the
stock market making only small steps toward recovery. In this climate,
the Fed is making profits.
That's impressive, isn't it ?
Unfortunately, the Fed's huge earnings
are a signal that the economy is still in terrible shape and that its
condition is worsening.
Let us take a closer look at the Federal Reserve's balance sheets,
at least to the extent that they are available to us. One year before
reaching their record-high profits, the Fed's assets consisted of
nearly $500 billion in government assets. These consisted of Treasury
bonds and assets issued by Fannie Mae and Freddie Mac, the two giants
of the real-estate market whose solvency is guaranteed by the federal
government. Since Fannie and Freddy are currently owned by the state,
their assets should be treated as state securities.
During 2009, the Fed was engaged in aggressive interventions in the
financial markets; through various operations, it increased the amount
of state assets in its possession to $1.8 trillion. The amount of
government assets on the Fed's balance sheet more than tripled. With
this huge increase in assets held, $46 billion is merely a 2.5 percent
return, which was provided directly by the government.
Therefore, the Fed's so-called "profits" are not a sign of the
coming of a great revival for economy. They rather mean that a
"Keynesian trick" has hid the decline in economic welfare. This trick
is often referred to as a "policy mix" — a mixture of fiscal and
monetary policies.
Here is how it works:
The newly elected President Obama increased
the budget deficit to a record high.The Treasuries for that debt are
released to the "free market."At the same time, the Fed started its
open-market operations, i.e., printing money and buying public debt in
order to put it on the balance sheet.Then, when this debt approached
maturity, the state paid the Fed for the issued debt (instead of paying
to the private investors).
But that is not all. Contrary to the claims of some groups, the Fed
is not a private bank: it cannot keep the profits earned from holding
public debt.
Over 90 percent of the money that the Treasury pays the
Fed goes … back to the Treasury. Thus, the modern state receives
earnings from printing money while giving a small fee to its financial
intermediary.
"From the market point of view the Fed is a bankrupt institution."
Here, in a nutshell, lies the whole mystery of the modern "print on
demand" scheme. There are no free lunches, but there are lunches being
paid for by somebody else.
Some news agencies claim that the Fed's profits show that taxpayers
did not lose money as a result of the massive bailout programs.
However, the facts are that Fed earned the money through government
securities. When the government does pay the Fed in order to boost its
"earnings," the money safely returns to the government.
Thus, the government and the central bank can show 'profits' ad
infinitum by endlessly pouring money from the Treasury's account to the
Fed's account and vice versa. Or better yet, the Fed can pay the
Treasury several times more by printing trillions of US dollars, buying
companies on Wall Street, and achieving small dividends.
Thus, the so-called "profits" are not evidence that the US economy
is doing well. Far from it, these profits are proof that the printers
are working long hours. Moreover, the state took upon itself huge
liabilities, which call into question the solvency of the entire
American financial system. It makes the hypothesis of a return of high
inflation more probable (although this scenario is currently still less
likely than further "deflation" of the credit).
We should use this opportunity to touch upon a different problem,
the accounting rules for the Federal Reserve. Unlike most financial
institutions, the Fed does not comply with the "mark to market" rule,
the principle according to which, in case of assets losing their value,
the books need to be revalued in order to reflect the market price.
If the securities issued by Fannie and Freddy and bought by the Fed
suddenly declined in value by 50 percent, the Fed would not need to
book the losses on these assets. This mechanism makes the central bank
not only a lender of last resort but also a market creator of last
resort.
The question arises:
what might happen if the Fed was faced with the
need to resell the assets in order to increase interest rates or stop
inflation.
Then we may find out that the Fed would not be able to sell these
securities at the booked price. To convince the private banks to buy
them through open-market operations, it might need to reduce the price.
Then the Fed would have no other choice than to record the actual
losses. This could even result in the Fed reaching negative equity.
If it came to this, there are two possible scenarios.
In the first,
the central bank would be recapitalized by the Treasury. This would be
an interesting scenario, in which the power to tax would support the
power to print, not the other way around.
In the other scenario, since
nothing precludes the Fed from having negative equity — it's not a
private company, traded on the stock market — there would be no
consequences. It might well continue its operations without any
noticeable difference.
But wouldn't that mean a collapse of the dollar?
The value of
liabilities would be much higher than the value of assets, while the
dollar would not even be covered by state-issued bonds.
In either case, one thing is certain: from the market point of view
the Fed is a bankrupt institution. History provides an example of a
currency backed by a phony real-estate market: French assignats, which ended up being completely devalued.
The only thing keeping the Fed alive is the protective umbrella of
the American state and its legal-tender laws. This is not a parasitic
relationship but a symbiotic one. What remains to be seen is how strong
this symbiotic bond is and how long it will take to succumb to
unavoidable decay.
Mateusz Machaj, PhD in economics; is a founder of the Polish Ludwig von Mises Institute. He's been a summer fellow at the Ludwig von Mises
Institute.
»
What's to prevent this scenario and maybe this is what has always happened. Congress votes 14 trillion. Fed, debits Fed 14 trillion, credits Treasury 14 Trillion. Treasury distributes.
Tax payers pay all the US taxes. Treasury pays Fed. Fed makes computer entry to credit Treasury, difference equals deficit. But where do the tax payer payments go? Fed deposits to account and distributes to all the owners. Imagine this scenario if the owners also own the rest of the central banks worldwide. What's to prevent this scenario? The owners receive all the tax payments of the US, and the rest of the world's tax payments made to all the other central banks. Is this not possible that this scenario is exactly what has always been happening? What's to prevent this situation? There is no external governance.
HAHA. That's funny!
We DO own all the Central Banks, worldwide!
Money, money where art thou?
Not in the vast, airless, monetary swamp here in the U.S.!
And to think that our illustrious representatives just
re-confirmed the swamp's facilitator & printing-press expert, Bee-Bop Ben.
I guess that pretty much seals the deal (and our fate) as far as Congress is concerned. All with the very helpful hand of the executive branch, I might add.
Oh, yes! And that slimy, rotten stench known as Geithner......what will happen to him? Well, methinks that these criminals need his stench around a bit longer so will ignore his putrid smell for as long as it "takes" (whatever that might mean.....).
Revolutionary? Absolutely. Insanity? Without a doubt.
We, too, might have to react similarly.
First, the owners never sell; they collect rents.
Second, the term "earnings" is phantasmagorical, especially when related to fed-treasury interaction both in-country and extra-country.
The old way of thinking truly dies hard....the new order relies on this.
40muleteam borax
so as the governments of the so-called prosperous nations of the world preach enlightenment and new world order and equality for all, the central banks of the world (and their favorite consituent banks) are above the stage pulling on the strings. and i see those dollar bills sticking out of those puppets' back pockets. the whole thing just reeks of rot from the inside out. sorry to reference my own username so liberally of course...
This house of cards can fall down from events in England ,
Japan , Greece, OTC Derivitives...... Go for safety >>> Silver
and Gold in your house...
The fun for the average joe will be: Is the metal I collect legit our plated.
(full disclosure: If I bought metals I'd be thinking that. That's if I actually have money to invest.)
Chop, good sheiße!
The Fedz lie on their own website:
Let's see...
$52.1 billion - $46.1 billion = $6 billion "printing/labor fee" for the Fedz.
http://www.federalreserve.gov/newsevents/press/other/20100112a.htm
$6,000,000,000 / 300,000,000 = $20 for every American. A Jackson note - the irony.
"If the American people ever allow private banks to control the issue of their money, first by inflation and then by deflation, the banks and corporations that will grow up around them (around the banks), will deprive the people of their property until their children will wake up homeless on the continent their fathers conquered." - Thomas Jefferson
The deflationary collapse that is now taking hold will inevitably come into public view as a deliberate strategy to bankrupt the middle class and force hundreds of millions of families in the West into foreclosure - so that bankers and financial speculators like George Soros can swoop in and buy up assets at pennies on the dollar.
If we’re to take the US and EU central bankers at their word, we’re going into a decades long deflationary abyss. No more money printing, no more stimulus, no more QE, no more bailouts. The future is parabolic increases in bankruptcy, foreclosure, lawsuits and congressional hearings. Some of you – even on this site – employ some twisted logic that suggests that this is going to be supportive of fiat currency. And it will, at least for a while.
Eventually, probably sooner than later, you end up with asset prices back down to pre-1980 levels and seriously pissed off people natively understanding that they were tricked into going into debt and loading up on assets – and losing everything when “they” pulled the pin and stopped the music.
Bankers and politicians will argue that unforeseen and uncontrollable market forces are to blame – and not the banking institutions themselves. The political response to that will be – “If they get a bailout, then we get a bailout.” Then what? Tough love and a sanctimonious speech about belt tightening? While trading desks are making a killing shorting pension fund assets?
Unless the central banks can generate inflation and growth, it is game-over for Western governments. Some of you are saying “collapse” and that may be what happens. Others are saying “hyperinflation” or “currency oblivion” and that is the most likely path forward in my view. Others think that there can be decades of pain on Main Street with collapsing assets and incomes and strengthening currency and government bonds. That is the one scenario that simply cannot happen. Despite the fantasies of a very small handful of rich people who think they’ll be able to take advantage of the misfortune of others.
Just imagine President Obama – or whomever succeeds him – going on television to announce to the American People – “Sorry folks, but all that money you invested in stocks and mutual funds and insurance policies is gone. You got tricked fair and square, and now its time to move on. And, by the way, you’re still responsible for any debts owed to banks and to the IRS”
Now back to your regularly scheduled programming.
The money supply was, for a decade or more, a product of the growth of the derivatives markets. When the money supply vanished as those derivitaves collapsed, credit & money flow in the economomy dried up.
This use of financial markets, instead of the banking system, to create money was new, an expiriment, and it failed. The money supply is a government function, delegated to the banking system and the Fed; letting that function fall into the hands of the financial marketeers was wrong, and stupid.
Now the Fed is recreating the money supply. There are numerous ways this could be accomplished; all have distributional consequences, and institutional consequences. They involve the use of the fed and the banking system to creat new money, through debt issuance, with the debt secured by assets - or government.
The method actually used in the US is for the Fed to take the debt of the Treasury. Some use the loaded term "printing money" or fiat money for this. All money is fiat money, except in primitive exchange economies, I find those terms worse than useless, and overtly disinformative.
Money created to replace a money supply which has vanished due to the collapse of a fantasy financial derivitaves pyramid is not inflationary, will not result in the collapse of the value of the dollar, or any other of the doom scenarios typically touted. It only puts back on the table the chips that have fallen off of it, so the economic game can contunue. That's it.
If there is a problem, it is that the money has been put on the table in the hands of the wrong players - the financial institutions - instead of the consumers and businesses who actually create economic activity. That has to be corrected - taxes on financiers and the greatest holders of chips seems the best way to do it, unless we can justify the creation of more debt by the government and its sale to the Fed. But that latter option seems nearly exhausted, politically, and perhaps even economically.
Money created to replace a money supply which has vanished due to the collapse of a fantasy financial derivitaves pyramid is not inflationary, will not result in the collapse of the value of the dollar, or any other of the doom scenarios typically touted. It only puts back on the table the chips that have fallen off of it, so the economic game can contunue. That's it.
That is right - and brings up the critical question in my view -
How much "money" just disappeared - and what debts was that money supporting? Yes - the CBs replace the money supply that had previously been issued by the 'shadow system' - but how much money are we talking about?
If its a few trillion that went "poof" - we've got a period of mild deflation ahead, and then a recovery to more "normal" levels of growth and inflation. If its $10-20T that went "poof" then we've got a more serious deflationary period ahead and more problematic inflation in the future.
If its HUNDREDS OF TRILLIONS - then all bets are off. That's a deflationary abyss that can't be overcome.
Time will tell how much "money" actually vaporized (and how much need to now be created and somehow stuffed into the economy to prevent "it ... " which apparent CAN happen here.
My guess is that the amount of counterfeit 'shadow bank' money that has disappeared from the system was much much larger than policy makers care to admit. The result will be multiple decades of contraction, deflation, depression, foreclosures, lawsuits, congressional hearings, special prosecutors, etc -
Good points -- we are in a deflationary depression because of the $trillions that have disappeared. If several $trillion disappeared, we might be able to correct; if hundreds of $trillions disappeared, we cannot. IMHO, we are certainly in the tens of $trillions, with the additional complication that worldwide derivatives markets are now north of $quadrillion (more than a thousand $trillion).
The losses will only increase as deflation continues, and it will ultimately result in a crisis of confidence: People will not trade their future labor for what is printed. We can "extend and pretend" for the moment, but this will not continue BECAUSE this printing is intended to claim future services, and the service providers will not accept it.
For example, US Medicare is unfunded at some $50 trillion, and you can't print that with the understanding that people will accept what is printed in exchange for providing health care. The US government will default when people won't get out of bed in the morning to exchange their labor for what is printed.
In the short run, the dollar will survive (because the Euro will disappear first). However, US sovereign default is absolutely imminent. There is no scenario by which US creditors will be made whole. We can only realistically talk about the next monetary system, and the volatile transition where government services default, creditors are betrayed, and debtors are forgiven.
Can happen. Will happen. Just because something is "unthinkable" doesn't mean it won't happen.
I'll take mine bloody if I can get Madcow's disease and flow like that! Great thread.
" From the market point of view, the Fed is a bankrupt institution "
Now that sums it up nicely for the institutional and central banking system at large. The trees falling in the woods and no one wants to see it or hear about it.
Disaster writ large.
The local, state and federal gov't CAFR reports show the entire story. After a fellow ZHer showed me Walter Burien's report it all makes sense. The gov't's pension funds hired hundreds of traders before the collapse. Their balance sheets show a $35trillion increase after the collapse and then they had the audacity to clean up their casino with US Taxpayer funds. The corruption and outright theft is too embedded. The melt up makes all the sense in the world. When I used to say "The market will stop going up when "They" decided it's time" was only said as a joke, but I never imagined, in a million years that that was the truth.
They will continue to fund the debt issuance with the funds they stole from taxpayers and when they want to crash the bond market they will sell their stake, watch the house of cards fall and buy them back for pennies on the dollar. $38 Trillion is a lot but they aren't done until they own every breath you take and put a tax on every fart you make.
So where does the Fed go to unload their toxic waste?
They have already dumped it in the cesspools known as Fannie and Freddy...
Excellent.The mark to hallucination currently practiced is a clear and present danger.
They are being accurate when they say an audit would be problematic.If an audit occurs and the balance sheet has an aggregate value 1/10 of what they have been claiming...Currency FAIL, followed by the rest of the vapor value balance sheets on the street.Dystopian nightmare follows....
The second point is very interesting: With an insolvent Fed, nothing would happen (because the Fed is protected by legal tender laws, and people need some unit in which to resolve transactions).
I've been wondering what happens if the Treasury hangs the Fed "out to dry" by issuing Treasury Greenbacks again (not through the Fed). In that case, the Fed dollar will instantly collapse to zero, but that would effectively ensure all debts are discharged, and the system is restarted, without the Fed.
We would eventually leverage up again, but that would give us another 80 years or so. ;-)
President Kennedy actually did issue interest-free
notes through the Treasury. They were called Kennedy
notes containing a red seal. You can still find them
in coins shops. They are not considered rare. Issuing interest-free notes through the Treasury effectively made the Federal Reserve unnecessay and many believe it is
one of the primary reason for events in Dallas on November 22, 1963.
agreed in principle but, in today's reality, how is the practical import of contemplating such any different than, welp, which specie of Snake just juiced your jugular aside Samuel L. on the plane ~ if such ever occurred, honestly, what would be the point of 'anything' cause i can guarantee you one thing, Mikla ... and though i do wish i could shut my playboy mouth, when willing to say 'mark that' n put my neck under Robespierre's Ruler, i rarely get my shirt turned inside out [in the process], so:
if (er, when) the lights do go out on mr. mkt ~ (1) uncle buck & papa yen are not going anywhere but up, up & Away: and (2) there is absolutely no chance in hell that anyone holding onto puts / calls sold across damn near any financial mkt will ever be paid out / made whole / given 'proper' trade cloture ... once 386x & 27xx DJ / YM are brutally punctured ~ if (and when, IM(oh-so)HO). failing 8200 DJ / YM makes even bill miller cringe and the next break of 742/ 741 ES / INX is not gonna be pretty. but now i'm putting the Veyron in front of the horse ~ complete n total off-peak conjecture w/o any backing provided. anyway.
thanks for sharing your thoughts, mikla ~ am an avid admirer of your work / insight(s) shared here on ZH. am extremely envious of your ability to synthesize so succinctly, hah; glad to be in such good company. thanks for sharing your time / thoughts.
Excellent article explained in a simple and concise fashion.
exactly! hence the ixnay on my own ranty bs.
Mises is on fire this week; giving TD / Marla a run for their Ameros.
Two AAPle pieces on Mises main splash are so money.
thanks for taking the time to check out and leave a comment, t DoC.
Thanks for getting this out Chopshop. I just happened to catch it over at Mises and was very impressed with his simple, concise breakdown of the Fed in a way that any attentive reader without much economic background can understand. Pretty unusual for a Phd. in economics. Having witnessed ad nauseam the convoluted ivory tower economic bullshit that exasperates the hell out of an ordinary person attempting to understand basic economics, I appreciate the simplicity which I find also in Alf Field and even the "unschooled" Martin Armstrong.
Interesting article. However, I don't agree with one aspect. FED IS a private company. It doesn't have the stocks issued on the exchange but it is owned by a consortium of domestic and foreign banks and banking families.
True, but the stockholders are not allowed to sell that stock. So, I've heard this interesting question before, "If you can't sell something do you really own it?"
Who wants to sell it? You get a 6% dividend along with that stock. Owners are making out like bandits, skimming 6% off the top of these fiat transactions.
Why on Earth would you ever sell? Surprised that the Queen of the Netherlands, nor Juan Carlos of Spain are not on the list; unless I missed it.
Here is a breakdown of the private members that own the Federal Reserve:
www.save-a-patriot.org/files/view/whofed.html