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Let’s Look a Little More Closely at What Bernanke Told Congress

March 2, 2013 in Economics

By Hunter Lewis

In Congressional testimony last week, Fed Chairman Ben Bernanke slipped something in that no one much noticed. He said that the Fed might eventually  choose to exit from its current monetary expansion binge, not by selling US government securities, but by letting them mature.

Let’s stop for a moment to consider what this means. At the moment, the Fed earns interest from the Treasury on bonds which it has bought with the money it has just pulled ” out of thin air.” It then pays its expenses, including the growing cost of the new consumer finance agency created by Dodd Frank that was placed in the Fed so that its costs would not have to be included in the federal budget. Since the interest on the bonds is larger than the expenses, in the end the Fed sends money back to the Treasury.

We aren’t told exactly how much has been deducted at the Fed, but we do see the amount of money returning to the Treasury. It’s a circular flow designed to obscure what is happening, which is the government simply printing money to pay its bills.

So what happens if the Fed holds a bond to maturity? In that case, the Fed presumably receives the principal payment from the Treasury and then sends that back to the Treasury too. In effect, the government has simply canceled its own debt.

When Adair Turner, a candidate for governor of the Bank of England last fall, said that the BOE would consider canceling some of the government’s bonds, this was considered a bit shocking, and the job went to Mark Carney instead. Now Bernanke has in effect announced an intention to cancel US bonds, and it doesn’t cause a ripple.

It can certainly be argued that it shouldn’t cause a ripple, that once the Fed has bought US bond with newly created money, the debt has already been canceled. But central banks like to do these things, step by step, as quietly as possible, and Bernanke has once again succeeded in making radical policy sound so boring that everyone slumbers as he announces it.

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