The US Treasury and the Federal Reserve: Redundant Institutions
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:
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.
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.