It seems like we are always hearing something about the Federal Reserve Bank, aka “The Fed”. Isn’t it the Fed that keeps printing money, somehow increasing our national debt? It sounds like something important, but we all have so many things to worry about that “The Fed” rarely gets a second thought. We have jobs, kids, parents, debts and all the other things that take up our day. Why worry about things that seem so distant and out of our control? Why, indeed.
Decisions made by the Federal Reserve do make a difference in our daily lives, but we do not equate its actions with the price of groceries or gasoline. Everything costs so much anymore, but we call it inflation. In fact, it is the Federal Reserve Bank deliberately devaluing our dollar in order to make goods manufactured here cheaper overseas.
Devaluation is supposed to create more jobs here. If a Ford is more affordable in Europe than a Fiat, we would need more workers here to make those Fords. After all, one of the Fed’s mandates is unemployment, so the thinking here is that more people with jobs will pay more tax. More tax collection means less reliance on the Fed’s quantitative easing program. So if this program is working, why does the Fed keep easing? It has to.
Since the credit crisis in 2008, U.S. spending has ballooned to about $3.6 trillion annually. This has created about 17 trillion dollars of debt, not all due to current fiscal policies. Unfunded wars and the creation of yet another entitlement program (medicare part D), along with tax cuts, have also added to our debt. How can our government pay interest on all that debt? Truthfully, it can’t, so here comes the Fed to the rescue. I will attempt to explain is how this works.
When the Treasury needs money to pay the bills, it issues bonds or IOUs at auction. Anyone can buy this debt, but most of it is currently being purchased by the Federal Reserve. Many call it money printing, but the Federal Reserve merely credits the amount of bonds purchased at auction to the Treasury.
These bonds, paying interest to the holder, are now on the Fed’s balance sheet. Bonds come in various maturities from 30 days to 30 years and currently pay very low interest rates. By keeping rates low, debt service is manageable. Should interest rates rise, paying interest on our debt would take a bigger slice of the budgetary pie, leaving other programs underfunded.
If someone other than the Federal Reserve were purchasing these bonds, the interest payments would go to them. China makes large purchases of U.S. debt and in turn we pay it enough interest annually to fund its military. If the Federal Reserve is purchasing most of the Treasury bonds at each auction, interest must be paid to it, but unlike another buyer, the Fed kicks back most of the interest to the Treasury. That is income that the Treasury would not receive from sovereign or private buyers.
Sounds OK, so what’s the problem? The Treasury is now at the point where it must sell bonds just to pay the interest on already-issued debt. Repayment of actual principal is all but impossible, so new debt must be issued just to pay off the old debt, creating a never-ending cycle of quantitative easing.
If interest rates rise for any number of reasons, we may soon come to a point when debt service is impossible. That will be when this elaborate scheme between the Fed and the Treasury falls apart. Who knows what the catalyst might be that sparks rising interest rates? Perhaps other foreign central banks will intervene when the goods they import get too expensive. Some say the “Arab Spring” was sparked by rising food prices in countries where a family might use 60 percent of its monthly income feeding itself. Fingers were pointed at Fed Chairman Ben Bernake, I recall.
So why should U.S. citizens worry about what the Federal Reserve is doing? Because your way of life and your future depend on it.
Carol Perry is a retired financial adviser and has been a Northern Nevada resident since 1983. She can be reached at Carol_Perry@att.net.