The whole process of money creation through central banking is still quite opaque to me. In particular I wonder about the following:
if the Fed buys US government securities then the government needs to pay the Fed back at some point, no? If so, how does the government benefit from these transactions other than by being able to go into greater debt (and because of the resulting inflation perhaps the debt will be less in real terms than what they got from the securities traders)? Can the central bank for example just 'write off' the securities so that the government does not have to pay them.
Thanks in advance for exposing and then decreasing my ignorance about this
See here: http://mises.org/Community/forums/t/4294.aspx
"You don't need a weatherman to know which way the wind blows"
Bob Dylan
This point is often brought up by those who say that private banks having the power to issue money will ruin society, claiming that the FED pretty much owns the govnernment.
To refute this, government debt at the FED is a minority of all government debt. Also, the FED is required by law to return the interest it is paid below a certain amount back to the govenrment. In most years, this is the majority of the FED's earnings on US treasuries. And, yes, even when they do earn something, they will likely receive devalued dollars.
To understand why this is helpful to government, it simply allows them greater access to wealth given various situations. When they borrow from the FED, they have a somewhat covert means of taxing dollar-denominated savings. This power becomes paramount in war and other situations where government requires such access to wealth to maintain its own survival.
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Conrad:if the Fed buys US government securities then the government needs to pay the Fed back at some point, no?
I'm pretty sure the FED is the one that issues the securities in the first place. (At least that's what I've been taught).
See here.
There are two reasons why the Fed would buy US gov securities.
1- Buying gov securities from the market to increase the amount of money in circulation. Think about it. The Fed has a lot of money and this secuities are just being traded in the market. The Fed thinks the economy needs more money in circulation so they buy them at market price. They get the govt securities in their balance sheet and they put more money in circulation. This is called Open Market Operations.
2- The Fed can also guy newly created govt securities from the treasury, this way the Govt has money to pay for what it needs (we get taxed to pay for FED money) and the Fed keeps the securities to earn them interest.
Was this helpful my friend.??
okay, thanks for the answers so far. To be sure, my question is only about how the government profits from these deals, not so much how the Fed wants to influence the amount of money in circulation. The link in the first response addresses that question. In that thread it is stated that the Fed does not write off the government's debt, but that the government benefits from being the first players to get the new money and because price-inflation is the result their debt will in net terms decrease. So these are two ways in which the government benefits. Another way may be that because the Fed's buying the securities increases total demand for them so that the price increases, but then the questio is why other players would still buy the securities when the price has increased.
banned: Conrad:if the Fed buys US government securities then the government needs to pay the Fed back at some point, no? I'm pretty sure the FED is the one that issues the securities in the first place. (At least that's what I've been taught).
You are right, the Fed does issue the securities through its treasury arm.
Private banks then buy the securities from the Fed, with a promise that whatever was paid will be paid back with interest. The Fed then knows that it has a certain amount of money that it has to create. Therefore the FED is the one taking on debt when securities are issued, not the government, although they are basically one in the same.
Okay, now I'm not understanding it anymore. the Fed creates the securities? so how or why can it buy them from the government? And how then does the Fed create money to pay back the Fed itself? sorry, I'm not understanding
The major point is that the government is pays much less than the official amount of interest they would owe if a private entity bought the same debt - the government often pays little, if any, interest. Given this, they x borrow money with y purchasing power today; and they return x money with < y purchasing power tomorrow. Furthermore, the government is continually borrowing more than it is repaying.
Almost every major war is financed in this fashion.
Check this out.
Conrad:Okay, now I'm not understanding it anymore. the Fed creates the securities?
Not quite. The fed sets the interest rate on the securities and they are loaned out through the treasury.
Conrad: so how or why can it buy them from the government?
It doesn't buy them from the government, firms buy them from the treasury and the fed buys them back once they've matured. When the fed buys them back they inject the money supply with the the price of the security plus the interest rate of the security.