At first I thought a recent Washington Post article regarding ‘earnings’ at the Federal Reserve was a joke. But it appeared in the business section, and there weren’t any “gotcha!” retractions the next day, so I assume it was meant to be serious.
For those who understand the very simple idea that the Federal Reserve prints Federal Reserve Notes (or their electronic equivalent) out of thin air, the concept of ‘earnings’ on those same thin-air money units is intellectually challenging.
Here’s the article:
Federal Reserve earned $45 billion in 2009
Wall Street firms aren’t the only banks that had a banner year. The Federal Reserve made record profits in 2009, as its unconventional efforts to prop up the economy created a windfall for the government.
The Fed will return about $45 billion to the U.S. Treasury for 2009, according to calculations by The Washington Post based on public documents. That reflects the highest earnings in the 96-year history of the central bank. The Fed, unlike most government agencies, funds itself from its own operations and returns its profits to the Treasury.
The numbers are good news for the federal budget and a sign that the Fed has been successful, at least so far, in protecting taxpayers as it intervenes in the economy — though there remains a risk of significant losses in the future if the Fed sells some of its investments or loses money on its stakes in bailed-out firms.
First of all, the word ‘earnings’ implies that value was created and/or something was at risk. Neither applies to the Fed. Let’s review the process by which they ‘earned’ money in 2009. We’ll simplify this by examining just one of their activities, the purchase of Treasury debt.
Step 1: Using keystrokes, create $300 billion out of thin air.
Step 2: Buy Treasury notes and bonds with the $300 billion.
Step 3: Collect interest from the US government on those notes and bonds.
Step 4: Report record ‘earnings.’
Step 5: Wash, rinse, repeat.
What is the meaning of ‘earnings’ in that series of steps? What value was created? Where was the risk? In this context, the word ‘earnings’ has no meaning or any relevance at all. It’s the exact same thing as if the Fed had printed 46 billion dollars put them on the income statement and called them ‘earnings.’ Or 10 trillion dollars. Or one dollar. When you can create any number you wish using a keyboard, the number itself is meaningless.
Further, we might wonder about the comfy relationship between the government and the Federal Reserve in which the Fed buys government debt, the government then pays interest to the Fed on that debt, and the Fed then (mostly) returns these interest payments to the government as “excess profits.”
In that little circle, the Fed reports profits and the government reports revenue from the Fed. They both ‘win!’ But the entire thing is really just a sleight-of-hand exercise, wherein the Fed prints money out of thin air and hands it to the government.
It’s a crafty little game with lots of moving pieces, but the essence of it is that money was brought into existence without any corresponding goods and services being created. Which means that it is not a good thing (as reported); it is actually a bad thing. It is among the most inflationary and dangerous monetary activities that can be performed, at least if the past 800 years of monetary history is any guide. It looks clever and sounds sophisticated, but it really is nothing more than a distributed tax on every outstanding dollar in the system. If the founding fathers despised taxation without representation, they would have truly hated this shell game.
Second of all, I reject the entire premise of the WaPo article, in that it promotes the notion that the Federal Reserve operates like any other normal business with a profit & loss (P&L) statement that in some way provides us with meaningful information.
The simple truth is that the Federal Reserve creates money out of thin air for the purpose of buying debt instruments. That’s it. That’s its entire business model. Sometimes those debt instruments are US Treasury bills, notes, and/or bonds and at other times (like in 2009), they are mortgage backed securities, destroyed CDS and CDO paper from Bear Stearns, GSE agency debt, and so forth.
The Fed business model is this: Thin-air money is created and exchanged for debt.
If any other company could perform such an operation, then it might be useful to compare their relative performances, meaning that a P&L analysis could provide some insight. But given that only the Fed has the power to manufacture new money from thin air, the P&L is nearly meaningless (and it is utterly useless without a corresponding audit and ‘mark-to-market’ accounting rules).
Since we have no idea to what extent the Fed is sitting on massive losses, or even what they are sitting on in many cases, the concept of P&L ‘earnings’ are as completely irrelevant as anything can possibly be. Thus, promotion of the idea of Fed ‘earnings’ is not just erroneous, it’s misleading.
Here’s another gem from the article that captures the essence of my point:
“This shows that central banking is a great business to be in, especially in a crisis,” said Vincent Reinhart, a resident scholar at the American Enterprise Institute and a former Fed official. “You buy assets that have a nice yield, and your cost of funds is very low. The difference is profit.”
“…your cost of funds is very low.” That part made me smile. It’s like me saying that the cost of using a calculator to multiply by a higher number vs. a lower number “is very low.” Yes, pushing buttons is a low-cost adventure.
A central bank is not a business; it is a government-enforced cartel with the unique ability to create money out of thin air. This is not a trivial distinction, and we would do well to view a central bank’s activities through a different lens than we use to view the rest of the productive world.
Instead, we would be best served by paying close attention to what the most powerful cartel is up to, as their private missteps become our collective pain. This is why I completely support the idea of having the Fed audited by an independent third party, just like any other public business.
If the Fed continues to refuse to submit to an audit, then I would support the establishment of a competing entity to the Fed that could also issue its own government backed currency. Then the marketplace (you and I) could decide for ourselves which unit of currency we’d prefer, using whatever information and data each would be willing to provide. One thing that nature has taught me is that competition makes for a stronger and more resilient organism.
Without any accountability, and with a complete monopoly, the Fed has grown weak and lazy, as evidenced by its horrible, serial-bubble-blowing performance over the past two decades and its apparent inability to differentiate between asset inflation and wealth. It is either time to enforce complete transparency, or, preferably, create some legitimate marketplace competition.
So that’s it: Let’s have an audit with publicly available results, or let’s have some competition.
Or maybe even both?
by bklement