The Fed’s Phony Benefits

There is very significant news that has barely made the headlines : Last week, the Fed has paid $89 Billion in benefits to the U.S. Treasury. It is 18% more than last year’s payment and it wipes out the $79 Billion 2010 record (Fed announcement).

By the way, in passing, the most profit-making entity in the USA is not Apple, Exxon or another company; no, it’s the central bank, living proof that the economy is upside down !

Once again, this payment is quite normal. The Fed gives back to the State all of its benefits, less its Washington headquarters operating costs and dividends paid to the twelve regional federal banks.

What is less normal is the source of those benefits : interest paid by the State on the Treasury bonds owned by the Fed. The system goes around in circles : the Treasury issues bonds, the Fed buys most of them (through the printing press), then it pays interest on its bonds, the Fed cashes it and then pays back the Treasury ! To be more precise, part of the Fed’s revenue also comes from bonds issued by Fannie Mae and Freddy Mac, also bailed out by the State... so it’s still a closed-circuit operation.

In other words, this debt acquired through the Fed costs strictly nothing to the State. It’s like borrowing at 0% interest. The total weight of the debt (interest paid to all debtors) was $251 Billion in 2011; so, that $89 Billion represents more than a third of the economy.

This is a very perverse mechanism because, as more of the public debt is acquired by the central bank, the less it weighs on the federal budget. It encourages taking on even more debt and have it financed by the central bank or, in other words, the printing press. And there’s also another perverse effect : this massive buying by the Fed causes interest rates for all bonds to fall, not only those owned by the Fed but those owned by american and foreign investors as well. Finally, the debt of the State is costing it much less than it should.

This is nothing but a gigantic bubble that, barring a return to balanced budgets, can only lead to hyperinflation.
All discussions on budget deficit reduction have to be understood in light of this reality. In fact, it doesn’t cost that much to finance the debt and the deficit if you include the Fed’s payment... so why bother cutting expenses ?