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Ben-anigans

Over time people have come to adopt a wide variety of instruments as means of payment. In more pastoral days, gold and silver and other specie were commonly accepted means of payment. In recent times, not only is paper currency accepted, but so too are credit cards, Paypal, e-Gold, etc. One consequence of this is that it has become much more difficult for the Federal Reserve to measure how much “money” is circulating in the economy (or so we are told).

Even if one understands that inflation is caused by an excess injection of money into an economy (“excess” defined as the rate of money growth exceeding the rate of growth in the value of goods and services produced), and if it is difficult to know how much money is entering the economy, then it is feasible to believe that the Fed has less of a command over inflation than we would like to see. This is the major reason why the Fed does not use rates of money creation as its way of controlling the level of prices in the economy. Its most salient tool to control prices is to perform open-market operations (see below) in order to affect the interest rate that member banks (members of the Federal Reserve System) charge to one another on loans of extremely short duration.

When the Fed wishes to see the price level rise, it injects money into the banking system by purchasing Treasury securities on the “open-market.” This money literally comes from nowhere, the Fed accepts Treasuries as assets on its balance sheet and pays for it with newly created deposits. These deposits in turn can be loaned out by member banks and it is thus that new money can enter the economy.To reduce the level of prices, the Fed will simply sell securities on the open-market, and withdraw money from circulation as it receives it on the sale of each Treasury – ultimately leading to a contraction in member bank lending.

Two things about this activity might raise some flags for interested observers. First, it becomes pretty obvious that the Fed and the Federal government are not independent creatures. While it is certainly possible that the US Treasury issues securities independent of whether or not the Fed will purchase them, it is not outside the realm of reason to expect that this possibility helps grease the wheels. Without central banks in the US or elsewhere to buy up these securities, Congress might actually have to watch its purse strings. Second, in the year 2008, is there any legitimate reason why the Fed must purchase Treasury securities as a way of injecting money into the economic system? It should be able to purchase any thing it wants. I suppose you will hear pundits saying that the Fed purchases Treasuries because ultimately it would be able to track its success at money creation/destruction by watching interest rates. A second justification is that the Treasury market is so large and so liquid that it is the only option that the Fed has.

Poppycock! So there are over $4 trillion in Treasury Securities outstanding, are there not markets that are as big? Or bigger? Maybe not. But two points are worth noting. First is that any open-market operation is much smaller than this $4 trillion. Second is that is there any reason why the Fed couldn’t purchase a large basket of goods/assets to execute the size of the trades they wish to?

I’d rather see the Fed buying up motorcycles, milk, maple syrup or whatever. At least that is more honest than propping up sectors that happen to be in line to get newly created bank credit, or popping sectors on the way out. And it is certainly preferable than continuing to allow Congress to spend hundreds of billions of dollars more than it receives in tax revenues every single year, and to allow Congress and the executive branch to promise retirees and young people alike $50 trillion or so worth of health care and retirement benefits that simply do not exist right now.

Of course, I’d rather see no Fed at all – but people seem to want their big government organizations. Fine, have them. But then throw me a bone and at least be honest about how those organizations are being run. What the Fed has always done, and continues to do right up to this day is misleading at best, and more likely outright dishonest.

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