Ac-cent-tchu-ate the Positive: The Fed’s Obscure Rule Change
Today at Mises I walk through my understanding of the Fed’s January 6 accounting rule change. My take is that the Fed’s description sounded like no big deal, because they implicitly focused on the treatment of earnings. What they didn’t mention was that their rule change shielded them from losses.
One thing: Some analysts have claimed that the Fed’s rule change would move losses on assets “from the left side of the balance sheet to the right.” I don’t think that’s correct. I think they will still mark down their assets, but instead of making a corresponding debit to their capital (on the right hand side), they will put in a negative entry under their liabilities (also on the right hand side). So the action is on the right hand side, moving something from one category to another. I don’t think the rule change affects the treatment of the left side at all.
The use of the word “earnings” by the Fed is deliberately misleading. If a CEO made a comparable statement they would be in jail.
This should have the greenbackers up in arms. There biggest complaint of the Fed is that the government pays interest on the debt to them when they could just print the money themselves at no interest. Obviously, since the Fed pays the interest back, minus salary and expenses, this complaint was dubious but if the fed has a negative liability to the treasury then the point stands. I bet they won’t even realize it now that Ellen Brown is in favor of the Fed all of a sudden.
The problem with your analysis is you look at the Feds balance sheet the same as you would look at a firms or a households. This is illogical and incorrect. Show me a firm that has unlimited revenues by printing. Show me a firm whose epenses have been greater than its revenues for over 90% of its existance over multiple centuries. Show me a firm that can ‘borrow’ for 30 yrs. at 4.64%, and whose demand for ‘bonds’ at its last auction was 3x more than the auction amount. I could go on and on…
To compare the balance sheet of the Fed or the public sector in general to a private sector balance sheet is not a valid comparison. The Fed cannot, and will not go insolvent unless a political decision is made to declare it insolvent. It can not, and will not go insolvent by having the asset side of its balance sheet lose value. The last time I checked the US Treasury was still the monopoly supplier of the USD. Insolvency/credit risk is exactly zero.
Everything you learned in accounting 101 does not apply to the Fed’s balance sheet.
Maybe you didn’t notice the link that explained why the Fed can’t go bankrupt like a corporation. Here is the opening to that article
http://mises.org/daily/4869
“In light of Bernanke’s plans to purchase $600 billion of longer-term government debt, many academic economists are beginning to worry: Could the Federal Reserve itself become insolvent? In this article I’ll explain these fears and I’ll argue that the Fed, with its printing press, cannot really go bankrupt the way other corporations can.
However, if the Fed should become insolvent from an accounting standpoint, more of the public would begin to realize just how nihilistic our central-bank, fiat-currency system really is. In that sense, further rounds of “quantitative easing”[1] are risky indeed for the Fed.”
The Federal Reserve refers to the “Interest on Federal Reserve notes due to U.S. Treasury” as “the distribution of residual earnings to the U.S. Treasury . . . made in accordance with the Board of Governor’s authority to levy an interest charge on the Federal Reserve Banks based on the amount of each Federal Reserve Bank’s outstanding Federal Reserve notes.” I’m not sure how this definition has been interpreted as the Federal Reserve pushing capital losses into a negative liability account.
I do not agree with the interpretation of the account as “simply eliminating one of the steps in . . . accounting.”
One blogger’s interpretation of this account interprets “Interest on Federal Reserve notes due to U.S. Treasury” as “making a negative capital situation technically impossible regardless of the size of the Fed’s balance sheet or how the FOMC chooses to tighten policy. . . any future losses the Fed may incur will now show up as a negative liability (negative interest due to Treasury) as opposed to a reduction in Fed capital, thereby making a negative capital situation technically impossible regardless of the size of the Fed’s balance sheet or how the FOMC chooses to tighten policy.” There is no evidence the Federal Reserve will recognize this liability as a negative figure.
Below is the history of the account “Interest on Federal Reserve notes due to U.S. Treasury” since it was first published:
(In millions)
Jan 05 – $613
Jan 12 – $1,204
Jan 19 – $2,895
Jan 26 – $1,292
Feb 02 – $2,047
Feb 09 – $1,263
Feb 16 – $830
Feb 23 – $1,803
No negative numbers. My guess is this liability account will never go negative. I could be wrong. We will wait and see what the future holds.
I just don’t understand the bases for which your article argues that the Federal Reserve will start recognizing a negative liability in its “Interest on Federal Reserve notes due to U.S. Treasury” account.