America’s Dirty Laundering

 No matter how many times they clean it, the fresh ink stains just won’t go away.

Forget, for a moment, about all the horrible economic damage the Fed is responsible for, according to its critics. News that just came out about the Fed’s massive payout to the Federal government ought to, by itself, raise the eyebrows of even the most ardent Fed apologists.

According to a recent Wall Street Journal article,

“The Federal Reserve turned $76.9 billion of its profits over to the U.S. Treasury last year, close to the record amount transferred to government coffers in 2010.”

The article goes on to explain that the Fed’s net income for the year was $78.9 billion, so it’s “dividend” to the US government amounted to about 97.5% of its total profits. The article then explains that the Fed’s portfolio of assets—the source of its profits—has increased from just $875 billion in 2008 to $2.9 trillion now, and of course a larger portfolio entails larger earnings. The article continues by providing more details on the Fed’s holdings (mostly government bonds and Fannie Mae/ Freddie Mac mortgages), and the risk/return tradeoffs of current Fed policies.

Yet strangely absent from this article, and barely noted by others, is any deeper indication of how exactly Fed “investment” works. Like any bank, the Fed has a portfolio of assets, on which it can earn interest income and capital gains. But where does the Fed get enough funds to treble its portfolio in 3 years? This is the dirty little secret of the Fed’s huge portfolio: its $2 trillion asset expansion was financed by the printing press.

Here’s how it works: the Fed buys, say, $10 billion in government bonds by crediting the accounts of one of its “primary dealer” banks with brand-new money (these banks can then expand their own lending at lower interest rates, which is the basic idea behind expansionary monetary policy). The government makes semi-annual interest payments, and a final principal repayment, on the $10 billion worth of bonds (plus the vast bond holdings the Fed already had amassed). The Fed takes a small chunk of this revenue for its operating budget, but the vast majority of its “earnings” is channeled right back to the US Treasury–$77 billion last year.

There’s a term for this in economics: inflationary finance. Although it’s a roundabout process, what’s going on here is akin to the Fed simply printing money and handing it to the government. This sets up dangerous precedents for an infamously spendthrift government, not to mention that it represents an unjust transfer of wealth from savers to the government.

Apparently these aspects of Fed operations are not interesting enough to merit the attention of mainstream journalists. Just routine monetary policy operations, they might say. I suggest another term for it: the world’s biggest money laundering scheme.

Tyler Watts is an assistant professor of economics at Ball State University.

image: www.flickr.com/alwayscurious