The Federal Reserve and the National Debt

Jerome Powell
Jerome Powell (Wikipedia)

The Federal Reserve System (“the Fed”) was established by Congress in 1913, and its Board of Governors is appointed by the President, but it’s an independent central banking system and not really part of the federal government. One of its primary jobs is to administer the nation’s monetary policy, with the objectives of maximum employment, stable prices, and moderate long-term interest rates.

The Fed’s primary tool for implementing monetary policy is the purchase and sale of short-term U.S. government bonds on the open market. When they want to lower interest rates to stimulate the economy they buy bonds and, in effect, print new money to pay for them. This increases the money supply so interest rates go down because the law of supply and demand applies to the price of borrowing money too. Conversely, when the Fed wants to cool off the economy to keep inflation in check, they sell bonds, thereby collecting money from the economy and reducing its supply, making it more expensive through higher interest rates. (Gold has nothing to do with the nation’s money supply. Gold isn’t money.)

The Fed’s Open Market Committee (FOMC) manages these bond transactions by identifying a target for the federal funds interest rate, which is the rate that banks pay to lend to each other. The Fed can’t actually set any interest rates, it can only set target rates and try to bring them about through its bond transactions.

In order to stimulate the economy in response to the Great Recession, the FOMC reduced its target for the federal funds rate to an unprecedented low of nearly zero in December 2008. The crooks on Wall Street, however, had destroyed so much wealth during the Bush administration that the FOMC took another unprecedented step by initiating large-scale asset purchases (LSAPs) to increase the money supply even further. These open market purchases, known as quantitative easing (QE), were made up of longer-term U.S. government bonds and longer-term mortgage-backed securities from the government-sponsored agencies Fannie Mae or Freddie Mac.

The historically low interest rates created by the Fed’s recent actions have created some economic anomalies, but they’ve certainly helped the U.S. economy to recover. The Fed’s long-term strategy, obviously, is to “taper” their bond purchases so that interest rates can eventually be normalized and rise to historical averages. It’s a tricky task because they could stall the economic recovery by decreasing the money supply too soon. They are using economic data to determine the best strategy, and have identified the unemployment rate as their primary indicator. Their focus on the unemployment rate, however, is problematic because ongoing structural changes in the U.S. economy have rendered one third of the current job seekers unemployable because the jobs they used to perform are obsolete and gone forever.

So, what does all of this have to do with the national debt, if anything? The U.S. government finances the debt created by the spending that’s approved by Congress and the President through the issuance of U.S. Treasury bonds – the bonds that the Fed purchases and sells to alter the money supply and manage interest rates.

But despite a record national debt of about $12 trillion at the end of 2013, the cost to the Treasury of paying interest on it has actually decreased since 2008 because of the historically low interest rates implemented by the Fed. Additionally, since 2010 the Treasury has been paying negative real interest rates on government debt because the inflation rate has exceeded interest rates.

This doesn’t mean, however, that the interest payments on the national debt are insignificant. According to the Congressional Budget Office, the net interest paid on the federal debt in FY2012 was about $220 billion and was projected to be about $223 billion in FY2013, or about 6% of the total federal budget. It’s a small amount in relative terms, but it still exceeds the budgets of many government programs. The National Park Service’s budget, for example, was only about $3 billion in FY2012, and NASA’s FY2012 budget was only about $19 billion. Furthermore, about 40% of these interest payments are sent overseas to foreign holders of U.S. bonds, especially China.

When the Fed decides the time is right to raise interest rates, the cost of paying interest on the national debt will rise considerably. Some estimates show normalized interest rates will result in interest payments on the national debt increasing to $1 trillion annually. This will create difficult choices, as less money will available for important government programs, including Social Security and Medicare.

The obvious solution is for Congress and the President to reduce the federal government’s debt. Most agree this must be done through a gradually implemented mixture of reduced spending and increased taxes, as simply making large cuts in government spending would send the economy into another recession. But getting Democrats and Republicans to agree on an acceptable combination has been difficult. It was made even more so by the recent strategy of right-wing Tea Party Republicans in the U.S. House of Representatives. In the fall of 2013 they created a government shutdown when they held the annual budget appropriations bills and a routine increase in the federal debt ceiling hostage in exchange for cuts in government spending and the enactment of some of their domestic policies. In the end, however, they had to back down from their radical strategy of political brinkmanship as public opinion turned against them.

We Have to Trust That the Federal Reserve Will Get it Right

So the bottom line is that the Fed’s Board of Governors, led by their newly appointed Chairperson Janet Yellen, will have some tough decisions to make in the next few years. They must figure out when the time is right to start normalizing interest rates. If they increase interest rates too quickly it could throw the economy into another recession, but if they do it too slowly it could lead to high inflation. And at the same time they must also consider that interest rate increases could significantly increase the federal debt. Many people are skeptical they can succeed in this high-wire balancing act, but they are very smart and experienced money professionals. We have few options but to trust they’ll get it right. A bigger danger might be that they have no more bullets in their gun if another economic calamity occurs before interest rates are normalized.

Updates

On November 2, 2017, President Donald Trump nominated Jerome Powell to be the next chair of the Federal Reserve, replacing Janet Yellen.

On January 23, 2018, Powell was confirmed by the U.S. Senate by a 84–13 vote, and assumed office as the Fed Chair on February 5, 2018.

On July 20, 2018, Pres. Donald Trump criticized the Federal Reserve’s monetary policy of gradually normalizing interest rates. In a Tweet he complained that, “Tightening now hurts all that we have done.” He said he was concerned that rising interest rates would make the unprecedented government borrowing created by his 2017 Tax Cuts and Jobs Act too expensive.

On October 11, 2018, Pres. Trump complained that the Federal Reserve “is going loco” by continuing to gradually increase interest rates after the U.S. stock market’s Dow Jones Industrial Average dropped by more than 800 points the day before. Interest rates, however, still remained well below historic averages.

On February 13, 2019, the U.S. Treasury Department reported that the U.S. government’s public debt had accumulated to an all time record of $22 trillion.

On March 9, 2019, Pres. Trump tweeted that the Fed had “mistakenly raised interest rates” and that U.S. GDP and stock prices “would have both been much higher” if they hadn’t continued to raise the rates.

On March 20, 2019, The Federal Reserve announced it wasn’t raising interest rates in 2019, citing a number of economic risks due to a domestic and global slowdown.

Translating Conservative Talking Points

joseph goebbels
“If you tell a lie long enough, it becomes the truth.” Nazi Propaganda Minister Joseph Goebbels – Wikipedia

I hope you will find this satirical list amusing – but disturbingly real.

Liberal lies: Facts that conservatives don’t want to believe, or are incapable of believing

Alternative facts: Lies told by conservatives to defend their irrational political opinions

Clean coal: There’s no such thing, but we’re willing to spend millions to convince you there is so we can keep polluting the air

The Deep State: Federal employees that insist on following the existing laws instead of bowing to right-wing political pressure

Energy you can depend on: Energy produced by burning fossil fuels

I’m against socialism: I don’t really know what it is, but government subsidies should only go to the programs that I like

Our public lands shouldn’t be locked up: Commercial exploitation by private enterprise is the best use of our public lands

Evolution is just a theory: The Bible is the verbatim word of God

Pollution controls are too costly: Polluters shouldn’t have to include all the costs of pollution in the retail prices of their products

God put natural resources on Earth for us to use them: Greed is morally good

The tax system penalizes successful people: I’ve made my money, so screw the rest of you

Class warfare: When the middle class complains they’re getting screwed by the wealthy class

Environmental regulations should be enforced in a balanced manner: They shouldn’t be enforced if they cost anybody money

Campaign contribution limits are a violation of free speech rights: Large corporations should be allowed to buy elections

America is Judeo-Christian nation: All other religions are un-American

Federal command and control: The Feds won’t let the states do whatever they want with the money they give them

Traditional America is dying: The President should be a white man

Pro-life: Women shouldn’t be allowed to make decisions about their own bodies

Public employee militancy: When public employees, such as teachers, decide they’re not going to let themselves be treated unfairly anymore

School choice: I want the taxpayers to help me pay to send my kid to a private religious school

Identity politics: When oppressed minorities have the gall to get politically organized to fight for their rights  

Require the best available science: Perpetually litigate the government’s regulatory process in order to paralyze it

Marriage is between a man and a woman: Homosexuality is an abomination against mankind

Racial unrest: When black people have the gall to complain about the police treating them unfairly

Global warming is a hoax: I don’t understand natural science, and don’t think I need to

Economic freedom: Being able to conduct business in a manner that hurts people or damages the environment without the fear of being held accountable

Religious freedom: Traditional Christian religious beliefs are more important than protecting everybody’s civil rights

We must secure the borders: We’ve got too many Mexicans in this country already

Arizona’s Sheriff Joe Arpaio just enforced the law: Who cares if his deputies picked on minorities, they’re the ones that commit the most crimes

We should return to the gold standard: I don’t understand what money is

We must drastically cut federal spending: But only the programs I don’t like

Private property rights: I should be able to do whatever I want with my property, even if it harms my neighbor’s

America is a melting pot, not a salad bowl: I don’t like people who are different from me

No spin: All opinions other than conservative ones are inherently biased

States rights: The Civil War wasn’t really fought over the practice of slavery

Judicial activism: When judges enforce laws I don’t like

Political correctness: Preventing me from saying cruel things to people whenever I want

Liberal indoctrination: When college classes are based upon facts and science

We shouldn’t pick economic winners and losers: The government should protect existing business interests

Protect the integrity of the voting process: Make it as difficult as possible for minorities to vote

Teachers unions are too strong: They won’t allow the teaching of biblical creationism in science classes

Fake news: Any factual information distributed by the media that undercuts conservative beliefs or political objectives

Stop chain migration: Split up immigrant families, separate immigrant children from their parents

Save Social Security & Medicare: Cut earned benefits enough to avoid any potential tax increases

Entitlements: Demonize Social Security & Medicare by implying that they are welfare programs

Gun control: Any limitations on gun ownership, especially common sense measures, school shootings are just a modern reality

Obamacare: Legislated expansion of health insurance coverage that’s inherently bad because it was promoted by President Barak Obama

The Real Threat to American Freedom

spirit of 76
The Spirit of ’76 (Wikipedia)

There was a lot of wood smoke in the air in my neighborhood during the last couple of nights. This was in spite of the fact that the Maricopa County Air Quality Department had declared  No Burn days. (Phoenix metro residents are prohibited from burning wood in their fireplaces on No Burn days because the smoke, combined with certain weather conditions, creates dangerous levels of particulates in the air.)

People who burn wood in their fireplaces on these days can be fined but I knew that whoever was violating the ban in my neighborhood probably wouldn’t get caught because the county doesn’t have many inspectors. It’s highly unlikely that any of my neighbors needed to burn wood to heat their houses, so they were probably doing it because they thought it was romantic to use their fireplaces during the holidays. But that’s a poor excuse, because wood smoke, in addition to being annoying, is a serious health threat to people with respiratory problems. Furthermore, too much smoke in the air could cause Maricopa County to fall out of attainment with federal health standards, which could lead to more severe air quality regulations.

Violating a wood burning ban might seem like a minor problem in the greater scheme of things, but I think it illustrates a more serious problem in America today. I’m talking about the widespread anti-government sentiment in our society. It seems to me that there are more people than ever before who believe the biggest threats to our freedom come from government regulations. I think this attitude was legitimized during the Ronald Reagan presidency. For example, one of President Reagan’s most famous quotes was, “The most terrifying words in the English language are: I’m from the government and I’m here to help.”

I have a hard time believing my wood-burning neighbors weren’t aware of the No Burn days, because the county has done a great job of publicizing them. I suspect their attitude toward the wood burning ban was, “Screw the government, they can’t tell ME what to do.” But it wasn’t the government they were screwing, it was their fellow citizens.

Unfortunately, many Americans have come to believe that freedom means they should be able to do whatever they want. But that’s never been the case. Freedom doesn’t mean you have the freedom to do things that are socially irresponsible.

The corrosive belief that our government is the enemy these days is largely the result of the constant stream of clever talking points fed to sympathetic politicians and media personalities by the numerous, well-funded, Orwellian-named, right-wing think tanks. Take a look, for instance, at what happened after the 2008 financial crisis that produced the Great Recession. The crisis was primarily the result of a lack of government regulation in the financial sector. But it wasn’t long afterwards that many Americans were convinced they should instead be angry about how the government intervened in the economy to prevent an economic collapse and promote a recovery. Another example is the rise of the Tea Party, and how they focus their complaints solely on the federal government and ignore the problems caused by the private sector.

Some government regulations are can be irrational and onerous, but the vast majority of them provide a useful purpose – and they can always be changed by the politicians we elect. Effectively administered government regulations will become more and more important as private corporations continue to grow in size and power. But if the entire regulatory process is demonized, the government can’t do its job. I suspect that’s just what the people who fund the conservative think tanks want.

Update

In November of 2016 Republican candidate Donald Trump, a millionaire businessman, won the electoral vote. One of his campaign promises was to radically deregulate the U.S. economy. After taking office, Trump appointed many corporate executives to high level positions in the government, including Wall Street financier Steve Mnuchin to Secretary of Treasury.

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