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The US Treasury and the Federal Reserve: Redundant Institutions

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September 27, 2010 – Comments (14)

These entities no longer have any real distinction, no longer serve the purposes that they did prior to 1971. In my post The Matter of Deficits, Sovereign Default, and Modern Monetary Theory I went through the process of showing why this was the case.

Here is the quick summary (please read the above post for a much more detailed explanation and accounting):

1) The US Government is not revenue constrained operationally (this is absolutely not true practically as all government spending must be supported by underlying private sector economic fundamentals to be sustainable, otherwise there will be real world contraints via inflation on the value of the Federal Reserve Note [US Dollar])

2) US Treasury bonds are not a financing tool. (It was under the gold standard, but that changed completely in 1971)

3) The role of US Treasury debt today is a monetary tool. It is the mechanism by which the Fed drains excess reserves in the banking system to maintain the Federal Funds Rate.

4) The Fed buys Treasuries during auctions in the exact amount that it needs to drain the system. This is why (unless the Fed gets temporary amnesia) every auction is designed not to fail. It can be oversubscribed by those who want to save in US Treasuries, but it will never be underscribed because the whole auction process is designed not to.

As I described in painstaking detail in the link above, the current distinction between the Fed and Treasury is as a hold-over from the gold standard. Currently, they are redundant instiutions, each filling one half of an operation.

Think of it this way:

I have a checking account and my wife has a savings account. When I want to buy something, I ask my wife to transfer funds from her savings account to my checking account and then I buy something. But this is unncessary. We are married. We live on one balance sheet. We are considered one financial entity in every legal aspect. There is no reason add complexity by dividing control of the accounts this way.

This holdover of having a seperate Fed and Treasury serves to reinforce the misconception that our financial system works in a way that it used to, but no longer does today. Is this inentional? Maybe. But it unncessary and costly. And the Pragmatic Capitalist has another very good reason for merging them, from the comment in this post:

http://pragcap.com/what-if-the-market-isnt-a-win-win#comments

making sense  said:

I was contemplating on the Fed Sept 21 “inflation target” statement and was wondering if the Fed is able to achieve it. I like this piece. If QEII fails, and the US becomes a 2nd Japan, the Fed can be ended as it will lose all its credibility and it will essentially become a joke.


TPC Reply:
September 27th, 2010 at 3:53 PM

Better yet, we can merge the tsy and Fed and stop pretending that they aren’t the same entity. Then maybe we can hold the Fed accountable as a govt entity and end their cushy relationship with the big banks.
[emphasis mine]

The current distinction allows the Fed to operate much more feely (and I would argue dangerously). It not only is an unncessary distincition, but it is really an obfuscation of how our system really behaves.

I for one would like to see more transparency.

14 Comments – Post Your Own

#1) On September 27, 2010 at 5:43 PM, 100ozRound (29.73) wrote:

I have a checking account and my wife has a savings account. When I want to buy something, I ask my wife to transfer funds from her savings account to my checking account and then I buy something. But this is unncessary. We are married. We live on one balance sheet. We are considered one financial entity in every legal aspect. There is no reason add complexity by dividing control of the accounts this way.

What you're supposed to do is just add numbers to your bank account and charge it against your children's future allowance...

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#2) On September 27, 2010 at 5:46 PM, MikeMark (29.83) wrote:

Nice synopsis. Thank you.

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#3) On September 27, 2010 at 5:46 PM, binve (< 20) wrote:

100ozRound,

ahhh, that's right. I will write little binvette a big IOU and go take a vacation :)..

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#4) On September 27, 2010 at 5:46 PM, binve (< 20) wrote:

MikeMark,

Thanks! No problem!..

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#5) On September 27, 2010 at 5:59 PM, starbucks4ever (99.05) wrote:

The bad cop - good cop split is formally redundant, but it still works. 

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#6) On September 27, 2010 at 7:02 PM, whereaminow (61.23) wrote:

binve,

I'm wondering about this.  The redundancy, though currently serving no function, may unintentionally help down the road.  I'm just spitballing here, but something to do with separation of interests - even though interests are currently aligned that might not be the case as the dollar collapses....  Perhaps the Fed and Treasury boyz might become more antagonistic.

What are your thoughts on this?

David in Qatar 

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#7) On September 27, 2010 at 7:46 PM, Varchild2008 (84.58) wrote:

Need to place a Printing and Borrowing CAP on the U.S. Treasury in terms of how much $$$$$ they are printing + borrowing versus the United States GDP.

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#8) On September 27, 2010 at 7:58 PM, binve (< 20) wrote:

zloj ,

okay

whereaminow ,

Hey David

>>even though interests are currently aligned that might not be the case as the dollar collapses....  Perhaps the Fed and Treasury boyz might become more antagonistic.

Now that is a very interesting idea. I had not thought along those lines. Hmmmm, I will ponder that one.

Thanks!

Varchild2008,

I think that would be a step in the right direction. I don't think theft by inflation (even though the current enviornment is not inflationary) should be our long term policy for 'economic sustainability'..

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#9) On September 27, 2010 at 9:17 PM, russiangambit (29.51) wrote:

#6 - not a chance. The only remote possibility is if  FED manages to screw up the system even more resulting in another blow out and US government to save the face will throw the FED to the wolfs. I see it more like restricting the FED's authority though, not completely liquidating it.

I wonder how many US congressmen / senators actually understand what the FED does since most of them are lawyers.

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#10) On September 28, 2010 at 12:43 AM, Tastylunch (29.54) wrote:

whereaminow

I personally doubt it, but who is to say what can happen when ego and politics collide?

it's my understanding is that they historically are more or less at odds.In past downturns whenever the Fed of old wanted to pull the punch bowl away, the treasury would try to step on the gas.

makes sense to me since most voters seem to vote on their own perceived economic well-being at the moment. So elected officials (and their beholden appointees) have huge incentive to attempt to stimulate/spend in almost economic environment. They don't have to care if it actually is beneficial for the US economy in the long run, but if activity can fake it for real productivty for an election cycle that's good enough Senator So and So to keep the lobbyist bucks flowing into his wallet.

It's only been the Capt. Good times let the bubbles blow Greenspan/Bernanke era where both insitutions have acted openly in such concert.

still I agree with zloj and russiangambit even in "normal times" it's more of good cop bad cop - dog and pony show. I'd think the deeper the crisis , the more they'd actually co-operate. In the end they view themselves as being on the same team.

just my unasked for 2 cents.

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#11) On September 28, 2010 at 11:13 AM, whereaminow (61.23) wrote:

Tasty, russian, binve,

Thanks for your thoughts!  I was looking for a silver lining. Alas! Damn optimism :(

Daivd in Qatar 

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#12) On September 28, 2010 at 11:30 AM, russiangambit (29.51) wrote:

#11 - if you are looking for optimism, how about that: when I was 8-10-12 y.o. I saw plenty of injustice and lies alla round me but I could never speak of it because 1) it would hurt me 2) it would hurt my parents. That was in early 80s. I was resigned to living all my life like that. I was reprimnded many times at school for not being more active in social/poltical life. By early 90s USSR and the communist party completly collapsed in a chain of events that nobody could've foreseen.

I think we are in the end game of the USA empire as well,. But it will not happen tomorrow. But I am pretty sure it will happen in the next 10 years. That is a reason to be  optimistic. What form it will take is a question, though. And even for those of us who want the change I don't think we'll be comfortable living through it.  And that is the other darker side of it.

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#13) On September 28, 2010 at 12:16 PM, mtf00l (43.86) wrote:

The Treasury and The Federal Reserve will never merge.  The Treasury is a department of the government.  The Federal Reserve is a privately help institution.  It wouldn't be as simple as the government buying GM, and the "investors" in the Ferderal Reserve would never agree to being "bought out".

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#14) On October 02, 2010 at 1:45 PM, paddyy (< 20) wrote:

Hi Binve,

They are different entities. That is the main idea.

Treasury is the entity that collects taxpayer money. (Government)

FED is the entity that has the privilege to control the money in the system.  ( Private Banks)

It is written ''Federal Reserve Note'' on the dollar.

If Government needs money, It has to borrow it from FED and pay interest to FED. It is the Treasury bond.

Treasury bond is the liability of the Government. Taxpayer money is the Receivables.

If Government needs more money, It can not create it.

It depends on whether FED wants to buy more Treasury bills.

You see,only FED controls the amount and rate of the money in the system.

For example, Congress decided to prevent financial collapse and borrowed money from the FED. That money went back to banks that own the FED. They simply put that money in their FED accounts and receive interest from FED.

So, FED borrowed money for interest. Money came back to FED not to the economy. They called it ''We saved the financial system''

The problem of millions of citizens who suffer from mortgage debt is not solved.

Since Government could not inject money to the system, unemployment is still high.

 US President can only appoint the president of FED.

Government can not audit FED.

 

 

 

 

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