The Federal Reserve Balance sheet is to the Federal Government what Fastow’s Loss Hiding “Raptors” were to Enron Corporation.
The Federal Government has a debt of at least $14.7 Trillion. Additionally, the Federal Reserve has a debt of at least $2.5 Trillion.
There is a simple way to avoid a sharp rise in the interest burden associated with a higher debt. The Federal Reserve Board can buy and hold the debt that is currently being issued by the Treasury to finance the deficit. The logic of this is straightforward. If the Fed holds the debt, then the interest on the debt is paid to the Fed. The Fed then returns the interest to the Treasury each year, meaning the net cost to the government is zero.
This technique is known as monetizing the debt.
In August, 2010 the FOMC (Federal Open Markets Committee) actually stated they would begin monetizing the debt with this anouncement:
“To help support the economic recovery in a context of price stability, the Committee will keep constant the Federal Reserve’s holdings of securities at their current level by reinvesting principal payments from agency debt and agency mortgage-backed securities in longer-term Treasury securities. The Committee will continue to roll over the Federal Reserve’s holdings of Treasury securities as they mature.”
Fed Gov’t Debt ($17.7T) + Fed Reserve Debt ($2.5T) = $20T. Debt is already over 140% of GDP.
The important lesson here, is that the Federal Reserve Balance Sheet can continue to absorb an infinite amount of Federal Gov’t debt, for Zero fee.
So, about Enron.
Enron created off balance sheet limited partnerships, these were named LJM1, LJM2 and Raptor I, I, III and IV. When Enron didn’t have enough money, it would borrow money from these off balance sheet partnerships. When it lost money, it could hide those losses in these partnerships.
The Federal Government doesn’t have enough money. Nobody wants to buy Treasuries to lend it more? No need to raise interest rates – just let the Federal Reserve hold the Federal Debt on it’s balance sheet, and since profits of the Federal Reserve are paid to the Federal Government, nothing is really owed, so we can keep this cycle up indefinitely.
Until the music stops.
The more junk stored on the Federal Reserve balance sheet, the less likely anyone outside of the Federal Reserve will buy treasuries – yet each time the Fed buys, it intrinsically expands the dollar supply and thereby devalues the dollar.
The Chinese Central Bank is determined to store overpay for large piles of US treasuries, and the US Central Bank is also determined to overpay for large piles of US treasuries, and other Toxic assets.
Future borrowing needs to move from easily devalued national currencies to a more difficult to devalue trans-national standard. I mentioned Special Drawing Rights two years ago, and they were really a pretty novel solution to the US debt problem at the time. Once the Chinese and Japanese central bankers come to their senses, if the Treasury wants to sell debt to anyone besides it’s Enron style Special Purpose Entity (the Fed), then it’s going to have to denominate debt in something more stable.