Gettin’ swindled by the Fed

Geoffrey Lawrence

The Washington Post today has an interesting story on the Fed’s “exit strategy.” The crux of the article is that, for an exit strategy to work, Fed officials will have to dutifully watch the impact that the Fed’s short-term interest rates have on long-term rates. If Fed officials keep short-term rates too low for too long, they could spur fears of inflation that would manifest themselves through a rise in long-term rates. However, if short-term rates rise too quickly then they could stifle any economic recovery.

The Post casts this scenario as a fine line that must be walked by studious Fed officials to achieve recovery without spurring runaway inflation. Essentially, the Fed is trying to sell confidence in itself. As Karen Dynan of the Brookings Institution puts it, “You’re trying to inspire confidence that you know what you’re doing, which can help put the brakes on any incipient inflation without damaging the recovery.” In other words, after more than doubling the monetary base in the last year and a half, the Fed recognizes that inflation is upon us but will now try to bluff the market.

However, as the article points out, the Fed has a new policy tool to use as a result of the TARP bailout legislation. In addition to targeting the daily Federal Funds Rate – its traditional policy tool – the Fed is now able to pay interest on deposits made by member banks. Because the Fed is able to print new money at will, it can now pay member banks not to make loans by printing new Federal Reserve notes and using them to pay interest on holdings. The policy goal of doing this is to take money out of circulation by encouraging banks to hold their assets at the Fed instead of using them to make loans. As the Fed offers higher interest rates, banks will take more money out of circulation and deposit it with the Fed where they bear zero risk and still turn a profit.

The outcome of this policy is a windfall for Wall Street. Whenever the Fed creates new money, it has effectively taxed the wealth of all dollar-holders by making each dollar less valuable. Traditionally, this backdoor tax has been used to profit the federal government with Wall Street serving as a middleman. The Treasury issues government bonds to be sold on Wall Street and Wall Street inevitably buys them knowing that they can later flip them to the Fed, which will print new money to purchase government debt. When the bonds come due, the Fed typically rolls over government debt, meaning that the Federal Reserve system serves as little more than a hidden taxation scheme that allows the federal government to monetize its debt with the assistance of Wall Street.

However, now the Fed can use its inflationary tax to reward Wall Street directly by paying interest on deposits. The result of this policy will be a massive wealth transfer from the bulk of Americans (and other holders of U.S. dollars) to Fed member banks.

It’s the bailout that keeps on bailin’ out!

Geoffrey Lawrence

Geoffrey Lawrence

Director of Research

Geoffrey Lawrence is director of research at Nevada Policy.

Lawrence has broad experience as a financial executive in the public and private sectors and as a think tank analyst. Lawrence has been Chief Financial Officer of several growth-stage and publicly traded manufacturing companies and managed all financial reporting, internal control, and external compliance efforts with regulatory agencies including the U.S. Securities and Exchange Commission.  Lawrence has also served as the senior appointee to the Nevada State Controller’s Office, where he oversaw the state’s external financial reporting, covering nearly $10 billion in annual transactions. During each year of Lawrence’s tenure, the state received the Certificate of Achievement for Excellence in Financial Reporting Award from the Government Finance Officers’ Association.

From 2008 to 2014, Lawrence was director of research and legislative affairs at Nevada Policy and helped the institute develop its platform of ideas to advance and defend a free society.  Lawrence has also written for the Cato Institute and the Heritage Foundation, with particular expertise in state budgets and labor economics.  He was delighted at the opportunity to return to Nevada Policy in 2022 while concurrently serving as research director at the Reason Foundation.

Lawrence holds an M.A. in international economics from American University in Washington, D.C., an M.S. and a B.S. in accounting from Western Governors University, and a B.A. in international relations from the University of North Carolina at Pembroke.  He lives in Las Vegas with his beautiful wife, Jenna, and their two kids, Carson Hayek and Sage Aynne.