Thursday, March 29, 2012

Government Buys Own Debt?

The WSJ reported yesterday that the Federal Reserve bought nearly 61% of all net Treasury issuance in 2011.  Now, it’s no big secret that this is happening, think QE2, but I about fell out of my chair when I read this article.  So, I have some questions about this rather unique exchange.

1. If the Fed buys Treasury bonds, and those Treasuries generate interest, does the Fed collect interest from the Treasury?  When I buy a Treasury bond, I get semi-annual interest payments and then collect my principle when the note matures, assuming I didn’t’ sell it.  Does the same transaction occur when the Fed buys Treasuries?  So, is the government just paying itself interest?  Seems dubious.

2. Is the Fed printing money? The Fed swears it isn’t printing money, but in essence, isn’t this what’s happening?  The Fed credits electronically the dealers it buys the bonds from, so while it may not be mechanically printing green dollar bills, it’s creating money out of thin air in the form of electronic deposits, no?

3. How long can this continue?  The article says this can’t continue forever but what or who can stop them?  Who knows how large the Fed balance sheet is – and does it really matter, except when it comes time to unload all this stuff.  How can the Fed unload trillions of Treasuries when US Treasury is also selling billions in treasuries?  Are there enough buyers to mop all this debt up?

4.  Isn’t the Fed simply financing the government’s own budget deficits?  This seems so weird and wrong that a quasi-government agency can purchase debt from itself.  How is this stuff even legal?

Perhaps the good Prof will jump in and answer some of these questions.  He may need his own post to do that!  


  1. I will expand on my answers in a post, but for now:

    1)Yes, the Fed earns interest on the bonds. I believe the interest may be remitted to the Treasury, but I'll have to look that up.

    2)Yes, they are 'printing' money. This is the precise transaction the Fed uses to manage the money supply.

    3)This is the big question. I have to gather some information before answering. My instinct is that there's already too much money in the bank system, so as soon as the cat gets out of the bag, all hell will break loose. When the cat flees is up for debate.

    4) Yes. See the history on central banks; they were created to finance government spending through debt purchases. I'll dig up some references for this matter. I think Rothbard will be able to help us out here.

  2. 1) I do believe you're right. The Fed does turn over interest to the Treasury. See:

    The Fed reported "83.6 billion in interest income on securities acquired through open market operations". Of this amount, it turned over about $77 billion to the Treasury. And this is counted as "income?" Huh.

    This then begs the question: why not ONLY issue Treasury debt to the Federal Reserve? Then, the Treasury can avoid paying interest on the debt. Of course, this is hyper-inflationary.

    1. I'm reading about the origins of the federal reserve right now. I'll see if I can find out why the structure is the way it is.