13 Feb 2015

Rand Paul Criticizes Fed, Pundits Flip Out

Federal Reserve, Shameless Self-Promotion 17 Comments

My latest at Mises CA. The conclusion:

Despite the minor mistakes in his presentation–which again was from a speech to a live audience–Rand Paul has put his finger on a very serious issue. Central banks around the world have loaded up on assets, particularly central government debt, in an unprecedented fashion. If and when they decide to raise interest rates, among other things such action could instantly render the major central banks insolvent. Not only would this possibly cause a worldwide financial crash, but it would also limit the central banks’ ability to reduce the quantities of fiat money. No doubt they would continue to operate, much as the banker in the board game Monopoly when he runs out of money, but that still doesn’t justify the situation economically. There’s a reason bankrupt firms stop operating in a genuine market economy.

17 Responses to “Rand Paul Criticizes Fed, Pundits Flip Out”

  1. Transformer says:

    I agree with what Rand Paul says about fed audits.

    But when he says of the fed:

    “They’d be bankrupt, they’d be insolvent,” he said. “[The Fed’s] liabilities are $4.5 trillion; their assets are $57 billion. Do the math.”

    Then, when you correct his “mis-speaking” and you swap “assets” for “equity” and look at what the balance sheet of the fed actually is (Assets = $4.487 trillion, liabilities = $4.430 trillion, according to O’Brien;s source) it turns out the fed isn’t bankrupt at all, and the whole point of his speech becomes invalid.

    Given this: Can you blame his critics for their responses ?

  2. Transformer says:

    And if had skipped the fed is bankrupt bit and just focused on:

    “They are leveraged 80-1. They are leveraged three times greater than Lehman Brothers was when Lehman Brothers went bankrupt. Why do we give ‘em a pass? Because they’ve got a printing press, and they can print up some more money.”

    Then that at least could be the start of a reasonable discussion about the role of monetary policy, and the kind of thing that Matt O’Brien says would a pretty good response.

    Do you agree ?

  3. Bob Murphy says:

    Did you click the link Transformer?

  4. Transformer says:

    Er, yes

    Otherwise how could I have quoted Matt O’Brien’s source on the CB balance sheet ?

    Did you read my comment ?

    • Transformer says:

      Sorry, bad day at work.

      Same reply, but assume away the attitude.

      • Bob Murphy says:

        No problem, I was worse in my recent post on Gene and Kevin Donoghue, I can’t complain…

        Anyway, I said upfront that Rand Paul had made those mistakes you brought up. But I don’t think Noah or O’Brien brought up the specific point about it not being insolvent yet. I would ideally want to hear a longer audio clip of Paul’s speech, before deciding whether he flubbed some things in the heat of the moment, or if he really doesn’t know what “insolvent” means. I could believe either, but I’d want to see more than a few sentences quoted on Bloomberg.

        • Transformer says:

          Also, I disagree with this:

          ‘3) Matt O’Brien says this is all wrong, because if the Fed became technically insolvent, nobody would care since it can just keep printing money.’

          The reason he gives that no-one would care is becasue its “borrowers” (holders of fed money) cannot come and ask for their deposits back like in a real bank and force bankruptcy, not because they can just print up more money.

          Insolvency for a central bank may be a political issue but it would never be a real economic issue.

  5. Tel says:

    The Fed doesn’t really have “Liabilities” in the normal sense. It just has an accounting fiction style of “Liabilities”.

    If a normal business or individual has a million dollars in real Liabilities, that means someone expects to be paid, and there are mechanisms to push that business or individual and make them pay it back.

    The FRN you hold is an IOU note and when you hold the FRN it is your Asset and the Fed’s nominal Liability, but you can take your FRN up to the Fed but you can’t make the Fed exchange that FRN for anything other than another FRN. They never pay their Liabilities in any tangible terms, and there’s absolutely no way to make them do so.

    Since no one can call them on it, they can leverage up to infinity.

  6. Chuck says:

    Rand should just say central banking was a key plank of the communist manifesto. That should be enough red meat for the idiot masses.

  7. Max says:

    In the first place, the Fed has a plan to deal with technical insolvency. It will stop paying out dividends to the Treasury. It’s a good plan. It will almost certainly work.

    In the unlikely event that that isn’t enough to make the Fed solvent, it happens to have a deep pocketed owner, the U.S. government. It’s hard to image any responsible government, regardless of how left-wing or right-wing, would deny the Fed necessary funds.

  8. Anonymous says:

    Add this commentary to the flipping out

    From David Kotok of Cumberland advisors:

    Now, there is another issue being used to conjure hyperbole and deception. The Fed is being attacked with regard to its capital structure. The antagonists say that the Fed is nearly broke, that it is leveraged 80 times its equity capital, and that if it were a private institution it would be insolvent. The fact is that the Fed is not a private banking institution; it is backed by the United States. My colleague Bob Eisenbeis had a long career within the Fed. He notes that, “As the central bank, the Fed has implicit capital representing the backing of the US government and the US Treasury. That’s the reason book capital isn’t relevant. It’s the implicit guarantee (actually, explicit guarantee) since US currency carries the logo “United States of America” and is legal tender.”

    The would-be auditors of the Fed keep alleging that the central bank’s leverage constitutes a risk. They are guilty of purveying misinformation.

    The Fed operates with no capital or only an insignificant amount. It is a central bank that does not need capital. It could operate with zero or negative capital. It could operate with a leverage ratio of 100:1, 200:1, or even 1,000:1. The Fed has an unlimited capacity to make payments. There is no issue of solvency with the central bank of the United States.

  9. Transformer says:

    These doctors – they walk into operating theaters and they cut people open. There are people serving life sentences in jail for less than that ! Why do we give ‘em a pass? Because they’ve got access to scalpels and can just buy more whenever they want !

    • Bob Murphy says:

      Transformer is for death panels!!

      • Transformer says:

        Well, can I assume that as we have an unfree market in the supply of healthcare (just like that in supply of money) you think the supply of healthcare should be frozen at some arbitrary level, just like the supply of money ?

        • skylien says:

          If money was like healthcare and as long as more healthcare doesn’t mean less of something else (like food, clothes etc..=) more health caresooner is always better, so if there was a CB of healthcare it should print print print as fast as possible.

          So why don’t you argue for the CB to raise its balance sheet by e.g. 1 Trillion per day? According to your argument above this is better than what is done now, or better than trying to get to NGDP of 5% annually? Why do you ask Bob if he thinks that “the supply of healthcare should be frozen at some arbitrary level, just like the supply of money ?” if he could ask you just the same? You just believe in a different arbitrary limit..

        • guest says:

          When sound money is used, the total supply never needs to be tracked, and percentage increases or decreases of the total never need to be known.

          The reason is because sound money is a commodity, itself, and therefore it will have a use-value which factors into at least one individuals’ preferences, and into at least one position in a rank of preferences; This use-value will be the basis for an individuals’ evaluation of the opportunity costs of acquiring it.

          So, sound money will increase or decrease in value based on its underlying subjectively assessed use-value to at least one person; Which is precisely the information you need in order to make sustainable business decisions.

          Prices in terms of sound money let you know what consumers want, whereas prices in non-commodity money misinform businessmen into wasting resources and consuming capital.

          • guest says:

            What it means for the supply of commodity money to be “too great” is that its trade value becomes so low that people will stop using it as money in favor of a commodity that holds more value.

            “Too little” supply of commodity money just means that its use-value is very high in relation to demand, and this information ripples through its trade value. People will naturally attempt to produce more of it.

            So, the supply of commodity money is self-regulating. No need for goverment involvement in money, and no need for Central Banks.

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