The Federal Reserve Is Directly Monetizing US Debt

cmartenson · November 16, 2019, 4:30am

The Federal Reserve is now directly monetizing US federal debt.

Sure, it’s not admitting to this. And it’s using several technical jinks and jives to offer a pretense that things are otherwise.

But it’s not terribly difficult to predict what’s going to happen next: the Federal Reserve will drop the secrecy and start buying US debt openly.

At a time, mind you, when US fiscal deficits are exploding and foreign buyers are heading for the exits.

How It’s Supposed to Work

Here’s how it's supposed to work when the US government issues new debt:

If the US Treasury needs to raise new funds, it announces an upcoming auction of US Treasury bills/notes/bonds.
A date for the auction is set.
Various participants bid for those bills/notes/bonds (including 'regular folks' like you and me if we're using the government's Treasury Direct program). This is the 'auction date.'
A few days after the auction, the actual bills are "issued" which is when the money actually changes hands and the bills are live in the market.
At a later date, the Fed can buy those US Treasury bills/notes/bonds. The various holders of that debt submit offers to sell, and the Fed (presumably) selects the best offers on the best terms.

The Federal Reserve, under no conditions, buys Treasury paper directly. The Federal Reserve’s own website still maintains that this is the case:

(Source)

There are two important claims plus one assertion I’ve highlighted in there, each in a different color:

Yellow: Treasury securities may “only be bought and sold in the open market.”
Blue: doing otherwise might compromise the independence of the Fed.
Purple: the Fed mostly buys “old” securities.

So according to the Fed: it's independent, it follows the rules set forth in the Federal Reserve Act of 1913, and it mostly buys “old” Treasury paper that the market has already properly priced in a free and fair system.

But that’s not really what’s going on…

What’s Actually Happening

It's now clear that something spooked the Fed badly in September.

We still don’t know what exactly went on, but the Repo market blew up. While this was a clear sign that something big was amiss, the Fed has not yet explained what the cause was, who needed to be bailed out, or why.

And it’s not going to anytime soon. It recently announced that its records on the matter are going to be sealed for at least two years.

While the Fed is ostensibly a public institution, and yes transparency should be extremely important – at least to maintain the appearance that it’s being careful with public monies – the Fed is prioritizing secrecy here.

Whatever’s going on has been serious enough for the Fed to openly lie. And not just in regards to the repo market.

“It’s not QE!” Fed chair Jerome Powell recently declared upon relaunching an asset purchase program that has already expanded the Fed’s balance sheet by hundreds of billion of dollars.

Given all the secrecy, obfuscation and lies, the Fed is now in clear violation of the spirit of the Federal Reserve Act of 1913.

Recall from above that the Fed “only buys Treasury securities in the open market”, meaning from other banks and financial institutions. That’s how the Federal Reserve Act of 1913 is written:

(Source – the Fed)

Let's walk through an example that connects the dots here.

Just know that this is but a single example out of many.

Data point #1

Each and every Treasury offering comes with an identifying number called a “CUSIP” number (referring to the Committee on Uniform Securities Identification Procedures).

On October 31^st, 2019 the Treasury Department held an auction for a series of 8-week T-bills with the CUSIP number 912796WL9.

November 5^th, 2019 those T-bills were “issued”, meaning that was the actual date that they were to become active. Before that date, nobody had possession of them and nobody was earning interest on them:

From the Treasury Offering Announcement above, on November 5, 2019, $40 billion of CUSIP number 912796WL9 were issued to the market.

It’s worth pointing out that no money changes hands on auction day (Oct 31 in this instance). It only does when the bills are issued (Nov 5 in this case).

Data point #2

Looking at the Federal Reserve's website, we can see what they bought and when (but not for how much).

There we find that very same T-bill with the CUSIP 912796WL9 showing up as having been purchased by the Fed Nov 5, 2019 – the very date of its issuance:

(Source)

The Fed bought more than $4 billion of this CUSIP. If these T-bills were out in the “open market” they weren’t there for long. At most, less than a day before the Fed scooped them up.

Does it really matter if a big bank sits ever-so-briefly between the Fed and the Treasury debt it buys?

Maybe to a trial lawyer seeking to get a guilty client off on a technicality. But this certainly doesn’t qualify as “old” paper.

This is the Fed buying huge amounts of very freshly minted – not even a day old! – government paper using the power of its electronic printing press.

What’s the practical difference between the Fed buying this directly from the US government and buying it same day it issues from a big bank?

Virtually nothing – except the big bank probably took home a very hefty paycheck for conducting this “service” as a middleman. Later JP Morgan, et al., can report magnificent “profits” from their ”trading activities”, which amounted to little more than calling the Fed the week before and asking how many $billions of these Treasury bills they wanted.

Just a temporary middleman who, if only skimming a single basis point (1/100 of a percent), would have gotten $400,000 in “trading profits” for holding onto a big pile of government paper for less than a single day, with a guaranteed buyer with infinitely deep pockets already lined up. Great work if you can get it, eh?

But not very fair. Nor even remotely in line with the spirit of the Federal Reserve Act. Or what capital markets are supposed to be about. Or the Fed’s actual mandate.

The summary here is this: the Fed is buying US government paper on the day it’s issued.

The Fed is directly monetizing US debt.

Which means…

MMT is Already Here!

The debate over whether or not MMT (“Modern Monetary Theory” see here for background and discussion) should or should not happen is now moot.

It’s already here.

Over the past year, the US government has spent ~ $1.3 trillion more than it took in. To cover the shortfall, it had to raid the Social Security piggy bank for (another) $170 billion and tap the “markets” for another $1.1 trillion.

If not MMT, what other name should we give a program where the US government spends $1.3 trillion more than it takes in and the Federal Reserve covers the shortfall by by purchasing US government debt on the day of issuance?

Does it matter if the US government issues it out of thin air, or if the Fed creates the same cash money out of thin air? Does it really matter in the slightest what the precise mechanisms are if the results are identical?

I would argue they don’t matter in the slightest.

All that remains now is to argue over what to spend all that fresh cash on.

Sure, some might like to debate whether we should be doing this or not. But the reality is: there’s little point in arguing over whether something should happen if it’s already happening.

Now all that’s left to debate is how much larger or smaller the Fed’s government debt monetization efforts might be.

Further, we might debate exactly what the government is spending all that money on. Or what the repercussions will be of the dangerous monetary road we’re now careening down.

But I’m not aware of any particular representative of mine even being aware of the situation, let alone concerned.

Conclusion

This is a very serious and extremely important conversation to have. But it’s not being had at all.

During Jay Powell’s last news conference, the Chairman of the Federal Reserve (and defender and champion of the largest wealth transfer to the rich in world history) was not asked a single question on this topic.

Nobody asked anything about the extreme and accelerating wealth and income gaps, both direct outcomes of the Fed’s policies.

Nobody expressed concern about the Fed’s secretive actions, its direct debt monetization, or its violation of the Federal Reserve Act.

The US media is toothless. I assume today’s journalists are simply too afraid of losing their jobs to speak truth to power, and have slipped into quiet acceptance of a mere stenographer’s role.

“Yes, Mr. Powell, you’ve reversed course and have started lowering interest rates again, and have resumed growing the Fed’s balance sheet via new QE. Oh yes, you’re right, it’s ‘not QE’. How silly of me. But despite those emergency measures, the economy is ‘in a good place’ and we all should be super optimistic? Got it. Yes, sir – very inspiring. Anything else?”

You’d think, given the enormous troubles that tend to follow central bank debt monetization that there’d be some curiosity on the topic, but no. No pushback from the media or Congress, direct or tangential.

Meanwhile the Fed has tossed a mind-boggling $285 billion of permanent new money into the “markets” over the past couple of months, and is conducting daily operations that put additional tens of billions of dollars of short-term money into the markets as well.

All while claiming everything is fine.

Sure doesn’t feel that way, does it?

In Part 2: Why The Risk Of A Correction Is So High Right Now, we demonstrate why the faith today’s investors are placing in the Fed’s ability to push prices ever-higher is dangerously overextended.

Stock gains have already zoomed way ahead of the Fed’s recent excess liquidity measures, and it will not take much to topple them.

Click here to read Part 2 of this report (free executive summary, enrollment required for full access).

This is a companion discussion topic for the original entry at https://peakprosperity.com/the-federal-reserve-is-directly-monetizing-us-debt/

mki-2-2 · November 16, 2019, 4:40am

Fed has tossed a mind-boggling $285 billion of permanent new money into the “markets” over the past couple of months, and is conducting daily operations that put additional tens of billions of dollars of short-term...All while claiming everything is fine.

I'm always puzzled at this sort of article. Fed bailouts are now the absolute norm. Sure, back in 2008 violating the financial laws may have been shocking & newsworthy. But after a decade and counting? Markets are now "markets", in the open, without apology. I concede maybe this was so before 2008 and only naive rubes like myself thought otherwise. But by 2019? it's a yawn. Everyone knows the score. Why write it up? Who would read it? Who would teach them to read? I think journalists, and everyone else, know the score. The public wants the bailouts, and will do anything to keep the money flowing. I saw this plain as day in 2008; people I knew well were willing to do anything to save their 401k's. And now the Fed has zero options, anyway: there is too much debt (public, private, corporate). They can't raise rates or taxes without the whole thing unravelling, they can only QE & drive up asset/stock prices. We had a choice in 2008 to take our hits. We really can't raise rates now without Armageddon.

rodster · November 16, 2019, 10:55am

“Everyone knows the score. Why write it up? Who would read it? Who would teach them to read?”
Because there are plenty of people who have no clue what’s really going on who are just living their daily lives and trying to provide for their families. It’s the same reason the Crash Course exist.

brushhog · November 16, 2019, 2:54pm

I never understood the big reaction to MMT and I never bought the branded package as being anything other than what we already have. What’s MMT say? Basically the government can create whatever money it wants with no restrictions to spend on whichever programs it likes. How is that different from what they are doing now? Maybe it differs only by degrees. The government is now creating over a trillion dollars a year to fund itself…maybe MMT wants them to create 2 trillion? 4trillion?
Can anyone explain the difference in actual practice? Im yet to hear it.

mki-2-2 · November 16, 2019, 5:12pm

Can anyone explain the difference in actual practice?

QE is monetary (which inflates stocks/bonds/RE). MMT is fiscal (cash directly to people). In layman's terms: QE benefits the well-off, MMT the have-nots. Or: QE embraces wage deflation; MMT accepts wage inflation. YMMV.

yagasjai · November 16, 2019, 6:53pm

Doesn’t this news mean it’s more likely that there would be a collapse in the bond market and that it’s less safe to park money in the Treasury Direct Program that we would otherwise have in a regular bank account?

uncletommy · November 16, 2019, 9:21pm

I remember reading this in August and I don’t see what’s changed since then. Monetizing debt does’t appear to affect the rich, but if you think we are approaching a deflationary cycle, a negative yield of .06% on 10 year bonds doesn’t seem like too bad an investment. (Short term; maybe a bit of money in the fracking business where roughly 60% of revenues staying in the driller’s pocket)
https://www.cnbc.com/2019/08/07/bizarro-bonds-negative-yielding-debt-in-the-world-balloons-to-15-trillion.html

steve-in-georgia · November 16, 2019, 10:44pm

Rodster, believe it or not, I see Millennials who are spending like there is no tomorrow. It’s like they are made of money. No plans for saving. Consuming with every dollar they earn. Completely clueless!

rocketdoc · November 16, 2019, 11:22pm

Perhaps they realize the “money” does not store value. There are several ways it can “go bad”. A money market fund breaks the buck, your bank pays no interest anyway and in a tight has a greater than zero chance of not paying you back. When my bank asks me for the last three years of my tax returns to maintain a line of credit, I tell them- do you see those .6%, 1%, and 2% CD’s sitting in your bank–I know they are “covered” by FDIC but I would still like to know your non-performing loan portfolio… I don’t owe YOU any money, you owe me.
I like saying it but saving unfortunately may actually be a mugs game…

rocketdoc · November 16, 2019, 11:32pm

I am no accountant. Does the general balance sheet of the Fed include ALL “other” open market operations? Several days ago I read the news about the repo operations of the Fed until the end of the year and saw some new 4-week, 8-week, etc. funding notes as well as the 14 day and overnight loans. Is the total more? Do they go to the balance sheet or are they an asterik? At some point it is possible to create hidden “folders” that no one talks about or accounts for. Like the old M3, it might just be a statistic we don’t need to know…

steve-in-georgia · November 17, 2019, 12:41am

@Rocketdoc … There are ways to “save” your wealth without giving it to the banksters or wallstreet. It’s clear from Chris’ writings above on the Fed operations, even if we participate in treasurydirect.gov, we are directly competing with the Fed… and I don’t have the billions to invest (LOL). But, my purchases are still competing with the Feds and consequently resulting yield is low. What about investing those “savings” into precious metals, land, training, community or in general an attempt at resiliency? Me thinks that tact is better than spewing it into the wind in the form of unleased consumerism.
BTW, if there are any folks here in Georgia (USA), please send me a PM. I would like to have a meetup.

ejhr · November 17, 2019, 11:33am

I posted, but it’s not showing, See if it can be found, please!

travissidelinger · November 17, 2019, 2:22pm

This is a very good article. Thank you PP team.
-Travis

mki-2-2 · November 17, 2019, 9:59pm

...there are plenty of people who have no clue what’s really going on...

The details, sure. But everyone (from the fast food worker to the guy laying drywall) knows the game is rigged and the government will do anything to prevent a financial crisis and keep the status quo for the fat cats. I've never met a single person who doesn't affirm this. Heck, even the movie Too Big to Fail has a scene where US Tres Sec Paulson orders his subordinate to (illegally) tell Lehman (a private company) to file for bankruptcy. No, all know the Fed is orchestrating the economy, and we would un-elect any president who let the Fed to pull a Volcker and do the right thing. Why? Simple. Americans are unwilling to take the pain of honest government finances and demand we kick the can down the road. This makes good sense: we are no longer one people; for better or worse it's now every man (and now every generation) for themselves. The real question, the one that everyone I know is waiting to know the answer to: how long can our bread-and-circuses capitalism hold together? I'm guessing a long time; America is still the cleanest shirt in a very dirty laundry pile (check out China or Europe where the free market has long been DOA). But I've been wrong before and only a fool doesn't keep their stop-losses set tight & ~10% NW physical gold in these crazy times...

rodster · November 17, 2019, 11:27pm

“But everyone (from the fast food worker to the guy laying drywall) knows the game is rigged and the government will do anything to prevent a financial crisis and keep the status quo for the fat cats. I’ve never met a single person who doesn’t affirm this.”
EVERYONE? Who’s everyone? Because the kids I try and talk to about our future perils don’t know a damn thing who and what the Federal Reserve is, they don’t know what the Treasury is for, don’t have a clue about Gov’t bonds, they haven’t a clue what the IMF or BIS stands for what, what there purpose is to the banking world. They give you a puzzled look if you begin to talk about central banks around the world.
So who’s everyone you are referring too? I find grown ups who have absolutely NO/ZERO clue about how our banking and monetary system works. All they care about is small talk.

rocketdoc · November 18, 2019, 12:12am

It is smart and necessary to save for a rainy day and for retirement. I have done so and don’t regret it–yet. But I have my doubts and I appreciate Chris’s clarity in writing about it. I have never been as lucid as he can be. My wife rolls her eyes when I talk about this stuff so I know my explanatory capability is marginal to the uninterested.
Why is it so hard to understand that you cannot actually save in imaginary money? It can go away when someone/anyone points out that the emperor has no clothes. But as many have pointed out, as long as we are all clapping for Tinkerbell, we do not have to face Reality. So if everyone else is constructing Reality for us, they are not interested in any sort of Truth that entails pain and complications. What is easier to believe–everything that you have worked for is at risk OR the government knows best and is trying to bring us all safely home with its machinations. We thoughtful types are “wreckers” (I think it was the communists that liked to call the people skeptical of socialism and the grand plans-wreckers). If I am a pessimist it is not because I WANT the status quo to fail–I am old and fully invested in it–it is because I feel I have a deep need for understanding the way things are(played upon the blue guitar) and wish to assure myself that I am not crazy. So thanks Chris. I may be crazy BUT I am not alone and crazy.
I wrote my first skeptical paper about our monetary system in high school in 1969. We had to pick a topic in 12th grade government/economics and I was interested in the claim that France(DeGaulle) was “stealing” all our gold by asking to redeem in gold all their dollars. They were being mean. I studied this wormhole for 2 months, grappling with the Breton Woods arrangement and the whole dollar pegged to gold system that was theorized to be modified by a bancor system called SDR’s that was a system of pretend “international” money that was going to serve as reserves for currency that the gold now was having difficulty covering because there wasn’t enough of it since France (and other countries) were demanding gold back at the official fixed exchange rate. Since I claimed at the beginning of the paper I was going to propose a workable international monetary system-I grappled with flexible exchange rates and throwing out the gold peg but then I couldn’t actually figure out what money was. The problem of fixed vs flexible exchange rates still didn’t answer the question of how to define what money actually was. I did not like the idea that the IMF could make a basket of currencies into something called an SDR that could be a reserve for all the currencies that composed it. It was a tautology I strained to penetrate as to why it was workable but finally had to cheat (plagiarize) an idea by a chap called Modigliani that said you could have crawling pegs that would give you the best of flexible v fixed exchange rates and the gold question would be solved by its increase in price.
Since then I have been in awe of how little people know about money. For something so important, it is a puzzle. People acknowledge that they work to earn money their entire lives!!! but if you ask them what it is, they say -a dollar -and it is obvious to anyone what a dollar is. Well, perhaps it is. A dollar is what the Federal Reserve says it is and as disturbing as that answer is to me, it doesn’t bother a majority of the population. I have often said 5% of the population knows it is a scam and 2% are bothered by it.
I was traveling in Italy in 1971 when this problem was addressed (can was kicked) for the first time. On August 15th I tried to pay my hostel bill with traveler’s checks and they were “worthless”. I went to the American Express office in Florence and asked why my money was no good and they said they would redeem them at 3x LESS than they were worth yesterday. I received no comprehensible answer–something about Nixon and closing the gold window. Did the float solve the problem of what money is? Obviously it did for as long as it has but I am waiting patiently for Reality to make an appearance.
Steve’s suggestion that we should buy valuable stuff is on target. Land is always land no matter how much you paid for it but of course can be lost by legal and illegal means: taxation or commandeered by the stronger and usurped by the weaker (squatting). No guarantees when trust is lost…

richcabot · November 18, 2019, 6:51am

“Does it really matter in the slightest what the precise mechanisms are if the results are identical?”
The results aren’t identical. The way it works now the bankers take a cut and (since the Fed is privately owned) also own the debt.

davefairtex · November 18, 2019, 8:09am

Here’s a link to the Fed Balance Sheet. Unaudited, of course. Real Banks get audited, but of course, the Fed is exempt from such pesky bothersome things like that.
Maiden Lane has been zeroed out at this point.
https://fred.stlouisfed.org/release/tables?rid=20&eid=840961#snid=840963

oliveoilguy · November 18, 2019, 3:21pm

Would someone please explain to me how this current monitization impacts etf bond instruments. I don’t pay a lot of attention to the markets, just have very diverse holdings and hope to avoid areas that are dangerous.

lesphelps · November 18, 2019, 4:26pm

For several years now, QE has closely matched the deficit.