In Congressional testimony last week, Fed Chairman Ben Bernanke slipped several things in that no one much noticed. He said that the Fed might eventually choose to exit from its current monetary expansion binge, not by selling US government securities, but by letting them mature. He also said that the Fed might possibly keep interest or principal payments for itself.
Let’s stop for a moment to consider what these two statements mean. At the moment, the Fed earns interest from the Treasury on bonds which it has bought with the money it has just pulled ” out of thin air.” It then pays its expenses, including the growing cost of the new consumer finance agency created by Dodd Frank that was placed in the Fed so that its costs would not have to be included in the federal budget. Since the interest on the bonds is larger than the expenses, in the end the Fed sends money back to the Treasury.
We aren’t told exactly how much has been deducted at the Fed, but we do see the amount of money returning to the Treasury. It’s a circular flow designed to obscure what is happening, which is the government simply printing money to pay its bills.
So what happens if the Fed holds a bond to maturity? In that case, the Fed presumably receives the principal payment from the Treasury and then sends that back to the Treasury too. In effect, the government has simply canceled its own debt.
When Adair Turner, a candidate for governor of the Bank of England last fall, said that the BOE would consider canceling some of the government’s bonds, this was considered a bit shocking, and the job went to Mark Carney instead. Now Bernanke has in effect announced an intention to cancel US bonds, and it doesn’t cause a ripple.
It can certainly be argued that it shouldn’t cause a ripple, that once the Fed has bought US bond with newly created money, the debt has already been canceled. But central banks like to do these things, step by step, as quietly as possible, and Bernanke has once again succeeded in making radical policy sound so boring that everyone slumbers as he announces it.
To make it even more complicated and confusing, Bernanke added that the Fed might also, for the first time, decide to keep the government’s money, not return the unexpended portion to the Treasury. Why would the Fed do that? The Chairman did not explain. But he must be worried that a rise in interest rates could result in a fall in bond values that would in turn bankrupt the highly leveraged Fed.
If the Fed’s capital base disappeared, the Fed could just print more money for its own use, but clearly the Chairman worries whether he has the statutory authority to do that. Not long ago, the Fed quietly released a statement that in the event of a need to refinance the Fed, the Treasury would be responsible for doing so. This has no clear statutory authority either. So the new idea may be to hold back some of the interest or principal payments the Fed receives and not return them to the Treasury so that our — the public’s money– can be used to refinance the Fed if needed without publicly asking the Treasury for money.
The Fed is not just ignoring or stretching its own statute in doing all this. It is ignoring the Constitution as well. Only Congress is supposed to be able to authorize the expenditure of public funds.