Many months ago I wrote of Shinzo Abe’s ambitious new economic plan for Japan and the subsequent expansion of the monetary base with which it was accompanied. I cited the fact that, beginning in early 2014, the Bank of Japan would begin buying government bonds at a rate of 13 trillion Yen ($145 billion) a month. I want to throw another figure out there – $85 billion a month. This is the rate at which the U.S. Fed has been buying bonds under the third round of quantitative easing (QE3), the latest program of asset purchases begun in September of 2012. It is expected that the Fed will expand their monetary base by another rough trillion before their purchasing campaign is done.
It’s often all too easy to lose sight of what these numbers actually mean. They quickly become mere facts once put on paper, devoid of any real life connotations or meaning. But the fact is that one trillion dollars equals a thousand times a billion, or a million times another million. The scope of the nearly continuous Fed buyback since 2008 is staggering. And so when Ben Bernanke and the Fed’s board of advisors affirmed again in the most recent Fed minutes their desire for a tapering and eventual cessation of purchases by mid-2014, given the correct economic conditions, it marked a change in Fed policy that carries with it huge potential ramifications.
The big question really concerns not when the Fed will end these buybacks, but what the consequences will be when they do. There is a sense that Bernanke and co. are pushing an inevitable reckoning down the road. It has been easy and inviting to talk of economic “recovery,” all the while ignoring the innumerable Treasury notes and the hulking mess of government purchased toxic assets, taken off the hands of Wall Street and forced onto the American public, that still lurk below the thin veneer of lies and jobs reports. So what happens when the music slowly trickles to a whisper, when the punch bowl is taken away in a way no one has ever seen before? Can the Fed really just let the trillions of dollars worth of accrued debt mature? They argue, naturally, that they can, but it really isn’t that simple. Will the Fed have to pay themselves, the owners of the bonds, when their maturity date comes? What happens when the interest on all these bonds comes due? None of these questions are being asked, but their answers, whatever they may be, will soon be made clear. Of course, by mid-2014 Bernanke will be long gone, leaving someone else to try and manage the fall.
Already 2008 is a dim memory; its bitterness forgotten by pundits now focused on other things. But the crisis hasn’t gone away. Five years later we are still dealing with its aftermath, manifest in the trillions of dollars the Federal Reserve (willingly) and the American people (unwittingly) took on. Easing very well might have staved off economic collapse then – but what about now? It’s a question that could shape 2014 and a long time afterwards.
I enjoyed reading both Mssr. Johnson’s article as well as Mssr.
Bell’s comments. I spent my early career on Wall Street at one of the two largest and most respected investment banking firms during the 1970’s and early 1980’s at a time when we were a partnership and were only risking funds of our own, and not those of shareholders and taxpayers as is custom today.
One of our partners went on to be one of the most respected Secretary of States as well as another who most likely will be remembered as the finest Mayor New York City has or will ever have.
Regarding Mssr. Bell’s comment I can only say that under today’s
accounting standards anything as proven by his comments can be justified as logic. One only has to look toward the Enron affair to glimpse the point. As far as the legal or platinum solutions he proposes, one must remember we are living in a constantly evolving global political economy, not a fairy tale.
I would only respond by asking if the future problems currently being accumulated by quantitative easing will be so easily corrected, then why are so many talented and creative investors and financiers such as Warren Buffet, George Soros, James Rogers, as well as hundreds of others so concerned about the path out at the end of the tunnel, which Mssr. Johnson has so eloquently spoken to.
“Will the Fed have to pay themselves, the owners of the bonds, when their maturity date comes? What happens when the interest on all these bonds comes due? None of these questions are being asked, but their answers, whatever they may be, will soon be made clear.”
Here is the answer to these questions:
Interest on debt held by the Fed is counted towards Fed profits, 94% of which get sent back to the Treasury. The other 6% go to the banks that own shares in the Fed. When the bonds mature, the Treasury will have to pay the Fed just like it would have to pay any other investor. The difference is that the Treasury will have gotten 94% of its money back. Actually, that isn’t completely true, since banks earn some middleman fees when they sell to the Fed. Essentially, the end result of QE is a net gain to the taxpayer of about nine out of every ten dollars involved.
All the concerns about unwinding QE from serious economists don’t have to do with bond maturation. They have to do with how QE affects the ability of the Fed to raise rates. See here for the perspective from a fairly conservative source (http://www.economist.com/news/finance-and-economics/21570753-what-happens-when-fed-starts-losing-money-other-side-qe).
Seen from the side of the banking system, what QE does is replace interest-bearing assets with cash, which earns no interest. Now, a bank with a lot of cash on its books will really want to lend that cash out, because if it doesn’t, it’s just losing money due to inflation. This could make it difficult for the Fed to raise interest rates in order to reduce inflation (and increase unemployment).
There is an easy fix for this: having the Fed pay interest on reserves, so reserves function just like government debt. The problem is a glitch in the law that requires the Fed to score these payments against its profits, which means that taxpayers ultimately may have to pay a similar interest on the reserves which have replaced the bonds.
Of course, this legal glitch could be fixed legislatively, but given the total insanity of modern Republicans on all things monetary, that could be difficult. Alternately, this legal oddity could be resolved by another legal curiosity: platinum coin seignorage. The Treasury could simply make up its losses by minting a monthly coin to make up for the missing money the Fed ought to be including in its profits. Platinum coins could also eliminate the rents we have to pay Wall St. for quantitative easing, if the executive branch were in a mood to eliminate government waste.