Fed Creates Money Out of Thin Air, Buys Gov Debt

Fed never going to shrink its balance sheet

Image Credits: Pictures of Money / Flickr.

Was Ben Bernanke lying or just wildly mistaken when he claimed the Federal Reserve wasn’t monetizing the debt in the early days of the financial crisis?

The Fed released the minutes from its January Federal Open Market Committee meeting yesterday. There really weren’t any surprises. The minutes emphasized the central bank will exercise “patience” in raising rates and also signaled that its balance sheet reduction program will end soon. A number of figures at the Fed have hinted that quantitative tightening will end in the near future, including Federal Reserve Governor Lael Brainard and Cleveland Fed President Loretta Mester.

As Peter Schiff put it in his recent podcast, the Federal Reserve balance sheet remains north of $4 trillion, and if the reduction comes to an end this year, you’re looking at a balance sheet between $3.5 and $4 trillion. In other words, almost all of the mortgages and Treasurys that the Fed purchased at part of its three rounds of quantitative easing will remain on its balance sheet.

On top of that, the central bank is now talking about using quantitative easing “more readily” and not just as a tool for emergency situations.

“And of course, that’s going to be their main tool given that this next recession is going to start when interest rates are at 2.25%, and so there’s not a lot of room for the Fed to try to artificially stimulate the economy when it hardly has any room to reduce rates.”

Peter said this confirms what he’s known all along.

“Quantitative easing is debt monetization. It is a permanent source of liquidity for the government where the central bank just creates money out of thin air and uses that money to buy government debt.”

Ironically, this has made Ben Bernanke out to be a liar. In the early days of the Great Recession, he assured Congress that the Fed was not monetizing debt. He said the difference between debt monetization and the Fed’s policy was that the central bank was not providing a permanent source of financing. He said the Treasurys would only remain on the Fed’s balance sheet temporarily. He assured Congress that once the crisis was over, the Federal Reserve would sell the bonds it bought during the emergency.

At the time, Peter said it wasn’t true.

“Now, whether Ben Bernanke knew it wasn’t true and was lying, or if he was just mistaken, nobody but Ben Bernanke knows. But at the time, I said, ‘That’s not true.’ I said there is no way the Fed is going to be able to sell off these securities — that this is indeed debt monetization. Well, now we know for a fact.”

(Photo by Medill DC / Flickr)

The Fed has made it official. The central bank is never going to shrink its balance sheet back to where it was before the crisis.

Peter said people act like this recent Federal Reserve 180-degree policy shift was a big surprise. They think the Fed was planning to keep raising rates and that it was going to continue reducing its balance sheet but it had to reverse course because “something happened.”

“They are missing the point that whatever that something was that happened was bound to happen from the start. I always said it was only a question of what the excuse would be for the Fed to abort the balance sheet shrinking and the normalization of interest rates. This was not a surprise to me. The only thing that surprised me was that it took so long to get to the point where the Fed had to call it off.”

Meanwhile, gold has pushed close to $1,350, a price that has created a lot of resistance in the past. Peter said he has a pretty good feeling that this time we’re going to cut through that resistance

In this podcast, Peter also did a little analysis of what MSNBC is saying about gold and highlighted some more bad economic news.

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