Tag: Monetary

The Fed’s Quantitative Easing Gamble Costs Taxpayers Billions

Tags Monetary PolicyMoney and BanksU.S. Economy

01/21/2023Alex J. PollockPaul H. Kupiec in Mises.org

[Reprinted with permission of the authors.]

The year 2023 is shaping up to be a challenging one for the Federal Reserve System. 

The Fed is on track to post its first annual operating loss since 1915. Per our estimates, the loss will be large, perhaps $100 billion or more, and this cash loss does not count the unrealized mark-to-market losses on the Fed’s massive securities portfolio. An operating loss of $100 billion would, if properly accounted for, leave the Fed with negative capital of $58 billion at year-end 2023. 

At current interest rates, the Fed’s operating losses will impact the federal budget for years, requiring new tax revenues to offset the continuing loss of billions of dollars in the Fed’s former remittances to the U.S. Treasury.

The Federal Reserve has already confirmed a substantial operating loss for the fourth quarter of 2022. Audited figures must wait for the Fed’s annual financial statements, but a preliminary Fed report for 2022 shows a fourth-quarter operating loss of over $18 billion. The weekly Fed H.4.1 reports suggest that after December’s 50 basis point rate hike, the Fed is losing at a rate of about $2 billion a week. This weekly loss rate when annualized totals a $100 billion or more loss in 2023. If short-term interest rates increase further, operating losses will increase. Again, these are cash losses and do not include the Fed’s unrealized, mark-to-market loss, which it reported as $1.1 trillion on Sept. 30. 

The Fed obviously understood its risk of loss when it financed about $5 trillion in long-term, fixed-rate, low-yielding mortgage and Treasury securities with floating-rate liabilities. These are the net investments of non-interest-bearing liabilities—currency in circulation and Treasury deposits—thus investments financed by floating rate liabilities.

These quantitative easing purchases were a Fed gamble. With interest rates suppressed to historically minimal levels, the short-funded investments made the Fed a profit. But these investments, so funded, created a massive Fed interest rate risk exposure that could generate mind-boggling losses if interest rates rose—as they now have.

The return of high inflation required the Fed to increase short-term interest rates, which pushed the cost of the Fed’s floating-rate liabilities much higher than the yield the Fed earns on its fixed-rate investments. Given the Fed’s 200-to-1 leverage ratio, higher short-term rates quickly turned the Fed’s previous profits into very large losses. The financial dynamics are exactly those of a giant 1980s savings and loan.

To cover its current operating losses, the Fed prints new dollars as needed. In the longer run, the Fed plans to recover its accumulated operating losses by retaining its seigniorage profits (the dollars the Fed earns managing the money supply) in the future once its massive interest rate mismatch has rolled off. This may take a while since the Fed reports $4 trillion in assets with more than 10 years to maturity. During this time, future seigniorage earnings that otherwise would have been remitted to the U.S. Treasury, reducing the need for Federal tax revenues, will not be remitted. 

While not widely discussed at the time, the Fed’s quantitative easing gamble put taxpayers at risk should interest rates rise from historic lows. The gamble has now turned into a buy-now-pay-later policy—costing taxpayers billions in 2023, 2024 and perhaps additional years as new tax revenues will be required to replace the revenue losses generated by quantitative easing purchases. 

The Fed’s 2023 messaging problem is to justify spending tens of billions of taxpayer dollars without getting congressional pre-approval for the costly gamble. Did Congress understand the risk of the gamble? The Fed tries to downplay this embarrassing predicament by arguing that it can use non-standard accounting to call its growing losses something else: a “deferred asset.” The accumulated losses are assuredly not an asset but properly considered are a reduction in capital. The political fallout from these losses will be magnified by the fact that most of the Fed’s exploding interest expense is paid to banks and other regulated financial institutions.

When Congress passed legislation in 2006 authorizing the Fed to pay interest on bank reserve balances, Congress was under the impression that the Fed would pay interest on required reserves, and a much lower rate of interest—if anything at all—on bank excess reserve balances. Besides, at the time, excess reserve balances were very small, so if Fed did pay interest on excess reserves, the expense would have been negligible.

Surprise! Since 2008, in response to events unanticipated by Congress and the Fed, the Fed vastly expanded its balance sheet, funding Treasury and mortgage securities purchases using bank reserves and reverse repurchase agreements. The Fed now pays interest on $3.1 trillion in bank reserves and interest on $2.5 trillion in repo borrowings, both of which are paid at interest rates that now far exceed the yields the Fed earns on its fixed-rate securities holdings. The Fed’s interest payments accrue to banks, primary dealers, mutual funds and other financial institutions while a significant share of the resulting losses will now be paid by current and future taxpayers.

It was long assumed that the Fed would always make profits and contribute to Federal revenues. In 2023 and going forward, the Fed will negatively impact fiscal policy—something Congress never intended. Once Congress understands the current and potential future negative fiscal impact of the Fed’s monetary policy gamble, will it agree that the looming Fed losses are no big deal? 

How Can We Restore Freedom and Sound Money in the US and the UK? Some Ideas

Patrick Barron for Mises.org

The purpose of this essay is not to convince the reader of the necessity for change. It is to present some commonsense policy changes to attempt to mitigate the economic harm that has been done to Western economies, especially to the United States and the United Kingdom, since the end of World War II. Please watch Godfrey Bloom and Alasdair Macleod’s recent interview with Sonia Poulton.

The video describes the current financial and reputational weaknesses of the West. For a more in-depth analysis of the financial threat to the West, please read any of Alasdair Macleod’s weekly essays from the past few months.

In the Poulton interview, Macleod ably describes the financial implications of the West’s deindustrialization policies and currency debasement. Bloom describes the reputational damage stemming from the West’s “sanctions” against Russia plus the consequences of deindustrialization due to the foolish pursuit of a Green New Deal.

This essay’s goal is not to convince the reader of the seriousness of the current situation, which Bloom and Macleod do so well, but rather to present policies that must be changed to stop the destruction of the West’s economies and reverse the harm to their reputations. Western nations need to build a reputation for honesty, fair dealing, and adherence to the rule of law in the international arena by embracing free trade and neutrality.

There is no need to point out that in the US and the UK, none of the policy changes listed below will be enacted by either of the two main political parties in their current state. Either one of the leading parties in each country must change leadership or a third party must emerge. There is precedence in both America and Britain for the emergence of a new party. In the mid-1850s, America’s Whig Party was thrown on the scrap heap of history when it was supplanted by the antislavery Republican Party. In the first half of the twentieth century, the Labour Party supplanted Britain’s Liberal Party. It has happened before, and it can happen again.

The following “policy imperatives” assume that such internal change has occurred and that the new ruling party must mitigate and eventually reverse the damage done by its predecessors over several years. The task will not be easy, nor will it be painless, but it must be done.

Policy Imperatives

1. Drastically cut government spending. The purchasing power of the dollar and the pound is being steadily weakened by the Treasury’s need to borrow more money than taxes and the bond markets will offset. Currently the central banks “buy” the excess debt with money created out of thin air. This leads inevitably to more money chasing fewer goods, which results in higher prices and the boom/bust credit cycle, among other economic damages.c
2. Abolish the so-called Green New Deal, which is based upon the schlock science surrounding “climate change.” The Western economies not only must end the destruction of their industrial economies, but they must revive the entrepreneurial spirit in individuals by eliminating regulations on business activity that does not directly cause real harm to people. For example, the West must stop mandating costly and time-consuming environmental impact studies, which elevate nonhuman life above human life. The US should abolish the Occupational Safety and Health Administration (OSHA), and the UK should abolish the Health and Safety Executive (HSE). Both countries have well-established common-law precedents that protect and compensate workersfor on-the-job injuries.
3. Reinstitute the gold standard. The dollar and the pound must be seen as proxies for real money; i.e., gold. This means that currency cannot be issued unless the central bank has gold with which to back it. There is a long list of economic benefits to be derived from a stable currency, but perhaps the most important benefit is spending discipline. The government’s myriad spending orgies will face real-time discipline from the taxpayers and the markets.
4. House the nation’s gold, which is used to back its currency, in a neutral and internationally supervised place—for example, Switzerland—that will redeem the nation’s currency for gold upon demand. The government must not be allowed to suspend currency redemption. Remember, gold is money and all else is credit. If a nation’s credit is in question—i.e., the market fears that there is insufficient gold to redeem all the currency or that the government may suspend redemption—then demand to hold its currency for settlement purposes will drop or even evaporate completely.
5. Return stolen property to its rightful owners. Theft is a violation of law at every level. The Western powers confiscated Russian property as part of the so-called sanctions following Russia’s invasion of Ukraine. This insult to justice must end. Neither country has declared war on Russia, yet the sanctions are well-known tools of war. Ending sanctions is both a moral and an economic issue. If the world believes that its property can be seized for some act for which a country’s government disapproves, international trade of all varieties will fall drastically for such a country and become difficult to recover. Who in the world can trust such a country again?
6. Adopt a noninterventionist foreign policy. The world is full of controversies that often lead nations to war. Unless their interests are directly threatened, the US and the UK must not intervene in foreign disputes but remain neutral, even if these disputes lead friendly foreign nations to war. There is no way that the Western powers can honestly adjudicate these never-ending disputes. The West should encourage diplomacy rather than war making. Otherwise, keep out.

Conclusion

The Western world has violated international norms of fair dealing to the point that its reputation is nearing long-term destruction. The West’s currencies are poised to fall in value due to unprecedented money printing over several decades. Western governments foolishly believe that there is nothing that the rest of the world can do. They believe that the rest of the world must kowtow to whatever international norms the US and the UK dictate.

But they are horribly wrong. The rest of the world is moving beyond dollar hegemony and beyond the reach of US and UK sanctions. It is building a new reserve currency for settlement of international trade. The non-Western world is much larger than the West in terms of population and commodities. More importantly, the non-Western world is willing to exploit its commodities for the benefit of its citizens, whereas the West has placed its commodities off limits due to its belief in and commitment to schlock environmental science that posits impending environmental doom.

The process can be reversed, but such a reversal requires new leadership. Nothing can be done unless new leaders can change policy. The West does not need to “rule the world” in order to be peaceful and prosperous.