So I've got this much...
The Federal Open Market Committee cannot “set” the fed funds rate by edict. When it wants to lower the rate it directs the New York Fed to inject cash into the system. The New York Fed lends money to major dealers in government securities, taking Treasuries as collateral.
But here are my questions: Is there not a finite quantity of said Treasuries for the FED to accept as collateral? And if there is, shouldn't this fixed quantity limit how far the FED can drop rates? What exists to ensure a sufficient supply of Treasuries is on hand at the precise moment that the FED decides to cut rates (particularly when the rates are cut unexpectedly)? Are member banks required to keep a certain amount of Treasuries in their reserves in the event that the FED decides to unexpectedly inject liquidity into the system, a sort of "Treasury reserve requirement?"
anyone? anyone?
Good question.
The New York Fed does not lend money to major securities dealers; it buys securities and pays for them with a check. These securities do not always have to be Treasuries. Last year, the Fed bought mortgage-backed securities.
If the number of securities remained constant, there would indeed be a limit to the Fed’s ability to manipulate the money supply. However, the Department of the Treasury regularly holds auctions in which they sell new treasury securities to the dealers. So, the Department of the Treasury creates new treasuries, which they sell to the securities dealers, which the Fed buys from the securities dealers using a check that is not backed by anything. This is how new money is created. The only limit is that the Fed, the securities dealers, and the Department of the Treasury all must cooperate in the process.
Jeffrey, when are you gonna have The Case Against The Fed in an online version?
Thanks for the response. The specificity is much appreciated. I presented Greg Mankiw (of blog and Harvard fame) the same question and he seemed not to have a clue what I was talking about. His response left much to be desired: "...I think the answer is that the [FED] changes in quantity of bonds via open market operations."
Clarifying questions: What backs these securities created by the Treasury Department? Are these newly created securities backed by tangible, value-based assets or are they claims on future fiduciary inflows collected by the government? In other words, are these "commodity-based" securities? Or are they simply pieces of paper with promises from the government ("fiat securities," if you will) to repay a sum of X dollars at a future date?
If they are the latter, it would then seem the Dept. of the Treasury is every bit as complicit in debasing our currency as is the FED.
Treasury securities are not asset based, and without new treasuries there would be limits on the Fed’s ability to increase the money supply through open market operations.
In fact, this is exactly what happened in the 1990’s when the Clinton administration supposedly “balanced” the budget. There was a reduction in the number of treasury securities and Fed watchers grew concerned that the Fed’s ability to control the money supply would be reduced.
Bingo. Why do you think this is such an untouchable area of American politics?!
The government uses the FED to monetize its debt. Without them, the government would be subject to raising taxes, which is politically unfavorable, or requiring individuals to buy its debt, which is not as quick or complete of a process. (recently, this is disputed with the swiftness China is willing to take our debt). The FED is more than happy to take this debt, because it allows them to create up to 9 times the debt's value in loans of new money (over time - it can only lend 9/10 out at first, but when that 9/10 comes back into the banking system, it can lend out 9/10 of that, and so on...until you end up with 10 times the total original debt [9 times worth of new loans, 1 times the original debt]).
Too many people get locked in a ridiculous argument that the FED is too private, and that elected officials are more accountable to the American people in issuing money. Rubbish. Most to all of the private interest the regional FED banks earn is paid to the government, which it uses as general revenue. Additionally, the FED is subject to Congress - Congress granted it the ability to monetize not only Congress's debt, but other governments, and now many forms of private debt. Why would Congress do this if Congress wanted better control of the money supply? If congress is so good with money, why can't they seem to follow a budget...year after year after year...
Others argue that the government is what misdirects the FED into bad policy, and the FED should be completely independent. It is true that the government's appointees do have a significant amount of control over the main parts of the system. Yet you rarely see any FED members publicly denounce the government and leave the system. They will not abandon such a huge privilege simply because they may disagree with some management decisions. If the FED were truly independent, then it does not make sense to give them special privileges. Should everyone be allowed to create money if they so choose? Why shouldn't every bank issue their own money, partially backed up by the "common money"? Why shouldn't every person issue their own currency? As Rothbard says, this defeats the entire point of having money in the first place...and this is why free individuals chose gold and silver as their universal currency.
Make no mistake - the FED is pure and simple a collusion of big banking and big government. Any arguments made by either side that deny or discredit this should be regarded as pure propaganda.
Check my blog, if you're a loser
I've been told that this is a very good explanation of the tools the fed has, but I've never been interested enough to read all the way through.
@ meambobbo
Great post, just curious...
So... perhaps what might be ideal is a completely open, free-market competition in actual currency? Gold, silver, paper money (backed 100% by X Y or Z) or e-gold, diamonds, vintage cheeses (joke!) or whatever the free-market innovates and finds most convenient and stable for the consumers and economy. Is this feasible though? Surely the FED can only exist because the government protects and guarantees its monopoly anyway, so the root cause is not our monetary system or the FED per say, but the actual violent enforcement of that monopoly on currency... the state itself?
Let's say, hypothetically, the state doesn't exist anymore and anyone can print paper money or exchange whatever currency they like. How do we go about 'regulating' (voluntarily I hope?!) the free-market in money creation/supply? Wouldn't the free-market itself provide regulation enough? Might we innovate some kind of new standardised electronic money system (convenient and fast) backed by assets or a mixture of other currencies (e-gold, e-silver etc)? Might banks as we know them today become obsolete under this system... except perhaps as sub-contracted storage or security agents of some kind?!
Just playing with some ideas! I'm not an economist (could you tell?!)
fingolfin:@ meambobbo Great post, just curious... So... perhaps what might be ideal is a completely open, free-market competition in actual currency? Gold, silver, paper money (backed 100% by X Y or Z) or e-gold, diamonds, vintage cheeses (joke!) or whatever the free-market innovates and finds most convenient and stable for the consumers and economy. Is this feasible though? Surely the FED can only exist because the government protects and guarantees its monopoly anyway, so the root cause is not our monetary system or the FED per say, but the actual violent enforcement of that monopoly on currency... the state itself?
But the state could exist in some form, clearly a different one, without a FED. It did prior to 1913.
I would make a great bureaucrat. Wanna see? Click here. It's fun.
Point taken. However I'm not debating the form and makeup of a state, or indeed the virtues of anarchism! What I'm curious about is whether or not the core economic issue is the violent enforcement of a monopoly on currency (by the state).
Fine, get rid of the FED - let the state control money issuance - or sure let the FED do it, with or without governance in the matter. Whichever. As long as there is no violent enforcement of any monopoly by the state. What I'm talking about is totally open competition in money supply/currency in the free-market. Is it feasible, if so how would it work today? Would the new FED be subject to checks and balances by market competition and just become another private competitor rather than today's stinking pillar of corruption?! Same question for a (non-coersive, optional) government backed 'standard' currency?
They might have an advantage in the market because of their state or FED official backing, or just the opposite, people might flock to the newer (digital?) currencies. What might this open economy look like?
STARBucks?!!!
if you take a look at what has happened to e-gold and the liberty dollar, clearly the FED and its government backers sees no room for competition. The secretary of the treasury told liberty dollar that it was a good, legitimate idea! Years later the FBI suddenly disagrees? This is in addition to the other obstacles, such as capital gains taxes.
FED privileges include a practice that pre-dates their existence which was equally distorting the monetary market by allowing a fraudulent fractional reserve banking system. Rothbard particularly lashes out at this, saying that banks can serve two functions, but not both at the same time. Either they serve as a preservation device, like a guarded warehouse; or they serve as an investment broker. One would have a agreed upon cost, the other having a cost of the risk involved, and part of the rewards possibly gained. Our current system serves neither purpose. Debasement through inflation allows the system to insure itself while earning money on investments with your money, but destroys the savings aspect of banking. With either a checking or savings account paying interest, you are losing money in real terms, while exposed to a risky system - it is unsure exactly how much you are losing. If the whole system collapses, you will be left with nothing, no matter what government assurances there are. the FDIC couldn't handle a bank run similar to the panic of 1907, from what i understand. and that's just to get paper money out of the banks. that paper can still crash in value, even without hyperinflation, so long as the majority of the market finds another currency more favorable, even with government restrictions.
the problem w/ fractional reserve banking is more than the risk, which is usually only discovered during the one true audit - a bank run. when the bank says they have your money and they can't produce it for you, that is fraud, a form of theft. the problem is deeper, as artificial credit distorts the market and leads to countless decisions in error, many indirectly linked to the bank's credit inflation. it is nearly impossible to assign accurate liability and secure justice. should we regulate the banking industry then? no, the market just needs to demand audits of ACTUAL money that the bank possesses and the market can regulate itself. When people see banks collapse without a central bank to bail them out, and bank customers actually lose their money, the market will certainly demand audits and a government that enforces fraud.
other privileges are legal tender laws (clearly unconstitutional) and the requirement for national banks to be FED members. The FED doesn't have the privilege of minting, however, it does have the privilege of being the only entity able to distribute into circulation t