Once The Fed’s Payments Will Dry Up, The US Budget Deficit Will Increase

Last week, the Federal Reserve announced it would send a cheque of almost $100B to the Department of the Treasury as it usually transfers a large part of its profit to the government. The $98.7B cheque is a rather big one and this brings the total payout over the last five years to $421B.

The annual cheque from the Federal Reserve is obviously a very welcome annual surprise as it helps the federal government to keep its budget deficit lower than it actually is. Without the $98.7B payment, the country’s debt to GDP ratio would have been closer to 104% compared to the 101.5% at this moment based on the payouts of the past five years.

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Let’s now have a look at how this profit was generated and what the future holds for the USA. As we all know, the Fed has been creating money out of nowhere in order to be able to purchase government bonds and mortgage-backed securities. This means the financing cost for the Federal Reserve is close to zero (it’s not exactly zero as there obviously are some overhead costs associated with the virtual money printing scheme). As the Federal Reserve obviously receives interest income from the securities it bought, the ‘institution’ is printing cash like never before. If one would assume an average yield of 2.5% on a $3.5B portion of the total assets of the Fed, roughly $87.5B is being created out of the blue.

This means that ending the Quantitative Easing program will be a bitter pill for the US government to swallow. Granted, the interest income over the next few years will still be substantial but this should decrease every year, thus effectively reducing the money being streamed up from the Fed to the Treasury Department.

Let’s fast forward five years now and assume the Federal Reserve has been unwinding its trillion dollar position in debt securities it gathered through the QE program. The profit numbers of the Federal Reserve will drop substantially. Granted, there will still be some money being streamed up to the government but this will be a marginal amount compared to the payout in 2014 (we would estimate the payments would be reduced by roughly 90%).

When keeping all other parameters and inputs unchanged this means the budget deficit will worsen by roughly $90B per year and the already dire situation will aggravate even further. As there are approximately 320M US citizens, the US government will need to find an additional income of $281 per citizen just to compensate for the loss in profit payments from the Fed (and to keep the deficit stable instead of narrowing it).

The US Dollar is still gaining ground on renewed safe haven-buying, but once the markets realize the US is in a worse shape than expected this could be reversed fast. The Congressional Budget Office is estimating a continuous budget deficit for the next decade and this will very likely push the Debt/GDP ratio to astronomically high levels. Even Spain’s Debt/GDP ratio is lower than the ratio of the USA right now.

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