$98.7 Billion Reasons To Be Mad

Rodney Johnson |

We have $98.7 billion reasons to be mad.

That’s how much of our money, taxpayer money, the Federal Reserve gave to the U.S. government in 2014. Over just the last five years, the Fed has funneled $421 billion, or almost half a trillion dollars of our money, to the U.S. Treasury.

The Fed takes this money from us without asking and uses it with no oversight by any elected official. When the funds flow back to the Fed, they simply hand it over to the U.S. government. Some people mistakenly think this gravy train is coming to an end.

No such thing will happen.

The Fed will continue earning record amounts of interest, and will keep funding the U.S. government instead of returning the funds to the proper owners… us.

Show Me The Money

When the Fed buys bonds, it does so with newly created money. The process is so simple, and yet so profound that it makes your head hurt. The Fed always buys bonds from a bank that has an account at the Fed. When the bank (electronically) delivers bonds, the central bank simply changes the amount of money that the bank has on deposit with the Fed.

It’s like going onto a spreadsheet and changing a number. Voila! The bank now has more funds in its account at the Fed, and the Fed has bonds.

The loser in all this is everyone who holds U.S. dollars. The value of our dollars is diluted by however much the Fed prints. Since the financial crisis, the Fed has printed more than $3 trillion, which is roughly 30% of the total amount of U.S. currency outstanding plus deposits in 2007.

The full effect of the dilution has not happened yet because banks have not lent out or invested the money they received from the Fed. Instead, banks are holding $2.7 trillion in excess reserves at the Fed because, since 2008, the Fed has paid interest on this money (I covered this topic in depth in the December issue of Boom & Bust).

Last year the Fed paid about $6.7 billion in interest on excess reserves as well as on required reserves.

The Fed gets money by collecting interest on the bonds it owns, which now total around $4 trillion (the Fed had $900 billion in bonds before 2008).

But the Fed collects more interest each year on the bonds it owns than it costs to pay its bills, including interest to banks and funding the newly-created Consumer Finance Protection Bureau. The Fed delivers all of its excess cash (which some call profit, but that is a misleading term) to the U.S. Treasury in exchange for… nothing.

It’s a gift.

But it’s not a free gift. Remember, the Fed originally bought bonds with newly created dollars that dilute all of the dollars in our pockets.

What the Fed should do with the excess funds it receives is simply reverse the original transaction. Whereas the Fed increased the size of the bank’s account when the Fed bought bonds, the Fed could reduce the size of its own account after paying all of its bills.

If it did this, then every dollar the Fed wiped out of existence would strengthen all the remaining dollars outstanding. This would give back to all of us at least some of what the Fed took in the first place.

Fat chance.

Instead, the funds will keep flowing to the U.S. Treasury, and people bad at math will keep talking about how “great” it is that the Fed gives cash to the government so that the government doesn’t have to borrow as much. They don’t understand that this is an un-voted confiscation of our dollars with no oversight!

Now many of these same people are concerned that as the Fed raises short-term interest rates, it’ll owe so much to the banks in the form of interest that there won’t be any (of our) money left to hand over to the U.S. Treasury.

There’s no reason to worry. The Fed won’t run out of (our) money any time soon.

The Fed earned north of $110 billion last year on its $4 trillion bond portfolio. As noted above, it paid 0.25% interest on $2.775 trillion of bank reserves, or $6.7 billion. If the reserves remain the same and the short-term interest rate goes up to 1.25%, then the Fed would owe the banks an additional $27.75 billion.

This would still leave the Fed sending around $71 billion to the U.S. Treasury at the end of the year.

But this assumes that the Fed would keep earning the same interest on its own bonds, which is not true. The Fed not only receives interest during the year, it also receives principal payments as bonds mature or, are called away.

When this happens the Fed doesn’t hold onto the cash or send it to the U.S. Treasury, instead the Fed buys more bonds in order to keep its holdings at the current level. In a rising interest rate environment, the Fed will be purchasing bonds that pay more interest at the same time that it owes more interest to banks.

For those that stay up at night worrying about the Fed having too little (of our) cash to hand over to the U.S. Treasury, don’t worry. It appears the gravy train will keep running for years to come, no matter how mad the rest of us become.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer

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