I have looked for awhile and just cannot find the information I am seeking. It seems that google has failed me, perhaps someone else will have better luck or already know a source for my needed information.

When the Federal Reserve buys Treasury Securities, or makes a loan to a financial institution at the overnight rate, where does the money come from?

I found one web-site which stated that all unused interest and fees collected from fed. activities were turned over to the treasury, returning the principle to wherever it came from, so the Fed. isn't building up a cash reserve overtime for it to loan out in the future. Does anyone have any reputable internet references which answer this question?

I was under the impression that the Fed. had the authority to make such loans and purchases without securing a revenue source, in a sense conjuring the money out of thin air. Was I mistaken?

I would like to thank anyone that knows a reference for the information I seek. This is not for school but the result of a monetary disagreement among friends.

12/20/2005 3:24:09 AM

Uhm...as I understand it "by pure fucking magic" is about as realistic an answer as any other.

12/20/2005 3:35:21 AM

http://www.amazon.com/gp/product/0912986212/103-2291087-1532606?v=glance&n=283155

12/20/2005 6:38:50 AM

Quote :

"where does the money come from?"

Ahh the joys of fiat money.

The federal gov't creates IOUs they call Treasury Notes. This instrument is considered an asset because it is assumed the gov't will keep its promise to pay. There is of course no actual money to cover these notes. Congress now wants the cash that these notes represent. (they're unwilling to get the money through tax-increases).

The Federal Reserve gives the gov't a check for these notes, thus creating cash out of nothing.
This check is deposited into the gov't's account. Then this money is sent out in the form of numerous gov't payment checks..thus flooding the economy with more and more fiat money.

Now these gov't checks are deposited into the banking system. This money is now added to the "reserves" of the bank. Fractional banking adds even more fiat money to the supply. The Fed allows banks to hold as little as 10% of their deposits in reserve. So if the bank gets a $1 million deposit from of gov't-issued check, they are only required to keep $100,000 of it in reserve. The other $900,000 is considered excess reserve and can be loaned out to produce interest.

So the total amount of fiat money created by the Fed and commercial banks is about 10 times the amount of the original treasury note.

This addition to the money supply works to inflate prices. Inflation is the secret tax we all pay to the gov't in the form of diminished buying power.

12/20/2005 10:53:09 AM

According to my economics textbook:

What happens to money the Fed earns?

"The Federal Reserve banks are very unusual corporations. Member banks can neither sell their shares on the stock market nor expect to receive a large share of the Fed’s profits, most of which are given to the U.S. Treasury. Member banks earn a 6 percent annual dividend on their stock no matter how much the Fed actually earns in a given year."

"[The Federal Reserve] earns interest income from its holdings of securities and from loans it makes to depository institutions. It earns, on average, more than $10 billion per year, but it returns the bulk of these earnings to the Treasury."


Where does the Federal Reserve get its money?

"The Fed pays for the purchase by crediting the deposit accounts of these banks at regional Federal Reserve banks. [...] The Fed can also pay for its purchase of government securities by issuing more Federal Reserve notes. This is another neat trick of the central bank—it can actually create currency. All the Fed needs to do is put in a call to the Bureau of Engraving and Printing and order a crisp, clean batch of new $10, $20, $50, and $100 bills to ship out to the banks in payment for the securities. The currency, of course, is just as much a liability of the Fed as the deposits it creates for banks."

So, yeah, they just make that shit up.

12/20/2005 11:04:19 AM

w00t

12/20/2005 2:10:12 PM

Thanks A Tanzarian. What was the title of your economics book? Gracias

12/20/2005 3:23:54 PM

Economics by NCSU's very own Professor Hyman.

12/20/2005 5:17:53 PM

EarthDogg

I'm not sure you understand the concept of fiat money. Today's dollar are not IOU's. The government doesn't promice to pay you anything.

12/20/2005 6:35:56 PM

Socko,
Our fiat dollars are not IOUs. But they are based on debt. Our money has no intrinsic value and would be worthless if not for legal tender laws forcing us to accept it as payment. The Treasury Notes are the IOUs.

The Federal Reserve, a semi-private cartel, has basically owned and controlled our currency since 1913. The gov't is stealing your purchasing power through inflation. We're not at the wheelbarrows of money for a loaf of bread yet, but something that cost $1.00 in 1913 -today will cost you $19.00.

12/20/2005 7:55:18 PM

Quote :

"The gov't is stealing your purchasing power through inflation"

So I guess the Fed was doing everybody a favor when they gave consumers all that additional purchasing power during the depression

12/20/2005 8:20:41 PM

Actually, majority opinion nowadays seems to be that the existance of the Federal Reserve caused the Great Depression.

As an example, some economists compare the 1930 recession to the 1908 recession. By some accounts, the economy going into the 1908 recession was worse but through quick actions the banking system was able to save itself by suspending demand deposits (if you have money in the bank, you can write someone a check but you cannot withdraw cash). It was technically illegal, but it prevented widespread bank failures. It required the creation of a consensus among the vast majority of banks in order for it to work, but work it did because the bank owners knew the next run could be on their bank.

Meanwhile, in 1930, the largest banks had the Federal Reserve to prevent their insolvency, so they refused to submit to a similar system, which resulted in widespread bank failures and ultimately a monetary collapse.

[Edited on December 21, 2005 at 12:02 AM. Reason : .,.]

12/21/2005 12:00:58 AM

^I was making a joke related to the fed causing the depression

because if inflation is stealing consumers' purchasing power then deflation is giving them more purchasing power

12/21/2005 12:20:45 AM

So true L-Snark, the Federal Reserve has been a most destabilizing influence on our economy. The Fed has manipulated the money supply over the years creating numerous periods of chaotic economic contraction and expansion.

You think we would've learned our lesson from the first three failed attempts at a central bank

12/21/2005 12:21:33 AM

1)Our money is "based" on debt.: False Normarlly the Fed uses Open Market operations (where it buys and sells t-bills on the secondary market) to expand and contract the money supply. Even though this is normally done using government bonds (t-bills ussually i think), which is a form of government debt, it could just as well be done using other assets. This was a legitmate policy question 5 years ago when we thought we might pay the debt down to zero.

2) Inflation is bad because it "errodes purchasing power" of our dollars:False
A monetary expansion eventually increases the prices of all goods and services including labor. As prices go up our incomes will follow. Even though it costs more to buy that sweater at the GAP than it did last year, it will still have the same opportunity cost--it will still cost the same portion of your income. In the long run, changes in the money supply only afect "nominal" variables, not real ones.

The same is true in the short run if a monetary expansion is fully anticpated. The expected inflation for next year will be reflected in forward contracts this year. So long as expectations match what really happens, there shouldn't be any problem.

So we can conclude that inflation is only "bad" (has negative consequences for real variables) if it is unexpected, which ammounts to saying that inflation is bad when it is highly variable. IOW: Inflation is only bad when it effects real variables. WHo gives a shit how much a dollar is worth?

3) The government uses inflation as a secret tax:False
In some countries this is true. In fact, in this country it has been true from time to time. But in the modern era this is not the case. In America today the only way inflation would benifit the government would be if it eroded the value its debt liabilities. This can only happen if inflation was not correctly factored into the nominal interest rate of government securities. Since the inflation rate has been fairly constant for about the past 15 years, chances are this hasn't been a factor of concern.

In fact, if the goal of the modern US government is to use inflation to wear away the value of its debt, then we can clearly see that they suck at the job at best. In the late 1970's the government was having to offer double digit nominal interest rates on its securities to get people to buy them thanks to the double digit inflation rate the nation was witnessing. By the late 1980's the inflation rate had slowed to the single digits and investors holding bonds from the late '70's saw their real rate of return increase, which means the US government actually saw its total debt liability increase.

IOW: Thanks to the Fed, the US government owes more money than it even intended. If the Fed was a cartel out to spare the US from paying its bills, why the hell did it SLOW the rate of inflation???

[Edited on December 21, 2005 at 1:07 AM. Reason : ``]

12/21/2005 1:06:55 AM

the man behind the curtain

yeah

don't look there

12/21/2005 1:07:58 AM

Quote :

"Thanks to the Fed, the US government owes more money than it even intended. If the Fed was a cartel out to spare the US from paying its bills, why the hell did it SLOW the rate of inflation???"

Because of the jews who want to put the nation in more debt so they can create the new world order.

EarthDogg's understanding of how the fed works simply doesnt work without the added insanity of a salisburyboyesque conspiracy.

[Edited on December 21, 2005 at 1:54 AM. Reason : ]

12/21/2005 1:53:29 AM

Quote :

"Even though this is normally done using government bonds (t-bills ussually i think), which is a form of government debt"

I'm glad we agree. You're right, our money could be based on something that is an actual asset such as specific amounts of gold or silver, but it isn't. It's based on what people feel it's worth.

Quote :

"it will still cost the same portion of your income."

Well.. inflation will help you if you're one of the first to get to spend the newly created money. And guess who gets to usually spend it first?..that's right the gov't. As this newly added money circulates, it lowers everyone else's purchasing power. Supply and demand should be the only elements that determine price fluctuations of goods and services. Inflationary effects are inserted by the gov't to help pay for its programs without directly taxing us.

Anyway you look at it, putting the power of controlling the money supply into such a small interest group such as the Federal Reserve Board is asking for trouble. The Fed has swung our economy up and down in booms and recessions. It has decreased our purchasing power steadily since its inception. It has not carried out the main purpose of its creation..to stabilize the economy.

Quote :

"if the goal of the modern US government is to use inflation to wear away the value of its debt..."

The gov't's goal isn't to use inflation to wear away value. It's goal is to generate the money it desires to pay for programs that couldn't be paid otherwise without massive tax increases. Inflation is merely the result of their desire for money. We lose because the gov't gets to spend newly created fiat money first, before its inflationary effects lowers everyone else's buying power.

[Edited on December 21, 2005 at 2:00 AM. Reason : .]

12/21/2005 1:58:15 AM

Quote :

"It's based on what people feel it's worth."

Just like everything else in the world...

12/21/2005 2:00:03 AM

gold has about as many practical uses as green paper with dead presidents on the front anyways

12/21/2005 2:13:02 AM

Quote :

"gold has about as many practical uses as green paper with dead presidents on the front anyways"

Commodity money is generally better because of the limited availability of its base. This is not to say that inflation cannot occur with commodity money. A lot of gold flooded the market at the turn of the 20th century when the cyanide process was invented.

But fiat money is subject to no physical limits. When the gov't wants more money, it simply prints it up so to speak.

12/21/2005 2:43:40 AM

Floods of gold also helped speed up the decline of the Spanish empire.

As it is, I have a fair amount of faith in fiat. There's no physical limits, but the wealthy (ie, those in charge) tend to suffer more from printing too much of the stuff than the poor do.

12/21/2005 2:45:42 AM

What if Bill Gates opened up a mall where the unit of currency was heart shaped granite rocks? LIke you could buy a digital camera for 40 heart-shaped granite rocks?

[Edited on December 21, 2005 at 2:49 AM. Reason : ]

12/21/2005 2:48:52 AM

n/m

[Edited on December 21, 2005 at 3:11 AM. Reason : ]

12/21/2005 2:59:26 AM

EarthDogg

Quote :

"I'm glad we agree. You're right, our money could be based on something that is an actual asset such as specific amounts of gold or silver, but it isn't. It's based on what people feel it's worth. "

You misunderstand my point. Just because the Fed buys and sells government debt to create money doesn't mean it is based on debt. If the Fed bought and sold gold to preform its open market operations, then that wouldn't mean our money is based on gold. The money is still just as "fake"

Open market operations (the buying and selling of bonds to expand and contract the money supply) are only the Fed's means of distributing to the fiat money it creates. The Fed could jsut as well drop money from helicopter's over New York to expand the money supply, but this would result in more of redistributional effets you speak of.


---

As far as redistributional effects go, you are right. If the fed expanded the money supply by just giving you a shit load of bills to spendm (and no one else knew about the transaction), then in the short run a great ammount of goods would be redistributed to you.

Of course, that's why the modern fed doesn't do things that way. Rather than buying and selling bonds from individuals, the Federal Reserve uses private financial institutions, which helps mitigate redistributional effects. And even if they did use individuals, so long as money growth is steady, businesses will anticipate the resulting inflation and adjust their prices accordingly. Both institutional process and rational expectations insure that any redistributional effect from a monetary expansion will be small.

If you really cared about redistributional effects from money supply growth, then you would abhor the gold standard. Gold is discovered and processed at irregular intervals (some years produce more gold than others). If Gold were money, then the person to find the gold first would be the one to benifit most from an "uneven" monetary expansion. This actually diverts resources from other productive activites to the business of mining/exploring/processing gold, more so than if gold were just another pretty metal people put on computer chips or necklases. It's hard to say what the welfare effects of this diversion would be, but wouldn't you rather have entrepnuers directing their energy to other aims than mining pretty metals out of the ground?

---

Lastly, we've been implicitly assuming that the federal reserve is the only one that can expand or contract the money supply. This is not true.

---


I have one question for you.....what makes Gold so damn special? Or more generally, why would we ever want a commodity based money supply?

[Edited on December 21, 2005 at 9:22 AM. Reason : ```]

12/21/2005 9:18:33 AM

^
An excellent question Socks. I will try to provide a response when I have a bit more time.

12/21/2005 10:48:39 AM