Tuesday, February 17, 2015

Does Rand Paul Really Understand the Federal Reserve?

By Robert Wenzel

As part of his "Audit the Fed" camapign, Rand Paul recently penned an op-ed at Breitbart.

In the commentary, he wrote:
The Fed has $4.5 trillion in liabilities and only 57 billion dollars in equity. It is leveraged at 80:1, nearly three times greater than Lehman Brothers when it failed...
If the Fed were forced to do, what every ordinary bank must do—take its “assets” and mark them to their current market value—many believe the Fed would be insolvent.

Politico correctly points out that this suggests a very poor understanding of the Fed by Rand:
[E]xperts say he gets many of his arguments about the Fed flat wrong...
"He seems to have a poor understanding of what’s actually on the Fed balance sheet and how the bank operates,” said James Pethokoukis, a scholar at the conservative American Enterprise Institute. “And if you don’t have a firm grip on one of your signature issues, people eventually are going to doubt other things you have to say.”
The case against Paul’s case against the Fed is fairly straightforward.
In his op-ed, Paul claimed that “[t]he Fed has $4.5 trillion in liabilities and only 57 billion dollars in equity. It is leveraged at 80:1, nearly three times greater than Lehman Brothers when it failed.”
In fact, the Fed has $4.5 trillion in assets, mostly Treasury bonds and mortgage-backed securities guaranteed by the Federal government. It has only $57 billion in equity because it sends most of its profits to the U.S. Treasury, a total of around $500 billion over the past decade.
And it actually has no “leverage” in the traditional sense of the word because it does not borrow money like Lehman Brothers did before it went bankrupt. Instead, the Fed creates money, as all central banks do.
“The capital of a central bank has very little importance relative to a private institution. The deposits cannot run. They are created by the central bank through asset purchases,” said Donald Kohn, a former Fed vice chairman now at the Brookings Institution. “There is essentially no credit risk on the Federal Reserve’s balance sheet right now, and I don’t know of any institution in the United States that is subject to more oversight.”
In other words, the chances of the Fed blowing up like Lehman are nil.
Indeed, the problem with the Fed is not that it can go bankrupt, if it could, that would certainly "end the Fed."  The problem is that the Fed can print any amount of money it chooses. Since Nixon closed the gold window, there is no check on how many dollars the Fed can print. That is, it can't go bankrupt.

The problem with the Fed has nothing to do with Rand's focus on the current capital structure of the Fed.

Further, Rand does not mention in his essay that  the Fed is the  entity responsible for the business cycle. (To understand how the Federal Reserve creates the business cycle, see Austrian School Business Cycle Theory.)

Not a word about this in his essay!!

As Ron Paul noted in End the Fed, the Fed's role in creating the business cycle is a key reason to end it. Ending the Fed would put a stop to the business cycle. But none of this from Rand. Indeed, it appears that he doesn't want to end the Fed, merely shift control of the money printing to Congress. Rand wrote:
I worry about the Fed’s independence from the Executive branch. The Fed is supposed to be overseen by Congress.
I have argued in the past, that this is a terrible idea. Do we really want the Fed influenced by Senator Elizabeth Warren?  Do we really want the Fed to be influenced by super-inflationists like MMT  economist and Senate advisor  Stephanie Kelton?

The Fed is an inflationist organization for sure, that answers to the banksters, but the banksters don't want hyper-inflation. When their money printing gets out of control, they tend to bring in those who will shut the inflation down. The banksters bringing in Paul Volcker is a prime example. But that check doesn't exist with Congress in control. Indeed, MMT economists consider money printing the answer always and everywhere.

I have gone off on a bit of a tangent here of who should control the Fed,when the focus should be on ending. But, this is what Rand proposals tend to do. They take the eye off the ultimate focus and redirect in ways that generally just muddy things up and make things worse.

Robert Wenzel is Editor & Publisher at EconomicPolicyJournal.com and at Target Liberty. He is also author of The Fed Flunks: My Speech at the New York Federal Reserve Bank. Follow him on twitter:@wenzeleconomics


  1. MMT'ers only want a long-term deficit of 5% of GDP YoY.

    Oops! Did I say "only"?

    It sounds like a lot.... because it is:


  2. The Fed doesn't want hyperinflation. True. Nobody does. But what the Fed wants more than hyperinflation is to preserve the U.S. banking and financial system in its current form. In order to do that, it will be required to maintain and enact the policy measures that ultimately result in hyperinflation. Fighting inflation Paul Volker style in the current era would destroy every large corporate financial institution in the U.S. The carnage on wall street would be epic. The Fed is not going to let that happen, and anyone who tells you otherwise is not living in reality. If there was ever a time for the Fed and the U.S. government to let things unwind, it was in 2009. That was their last chance to let the banks go down and save the dollar. Instead, they entered the monetary twilight zone where they remain to this very day. There is no simply no realistic way of unwinding things now. I think even people knowledgeable about economics and finance fail to grasp the enormity and seriousness of what has taken place over the past six years with all the QE and a Fed funds rate held perpetually near zero. This is not normal policy. These are desperate measures taken by a western world staring financial death in the face. Some call it "The End Game". This end game ends either with hyperinflation or with a new currency introduced by the government before the hyperinflation destroys the dollar. Either way, the U.S. dollar in its current form is being sacrificed on the altar of the western banking system.

    1. What will happen to the gold price (priced in dollars)?

    2. It could be either 0 or infinity, if holders of gold won't accept dollars in exchange for gold. Who knows?

  3. We always ignore the enormous credit component of the money supply. The Fed enables bank credit expansion.

  4. I think the capital structure is important! If long-term rates increase, the existing book of assets on the Fed's balance sheet would be reduced in value via MTM accounting. Negative equity and a loss of confidence is possible, right?

    Regarding the asset component, Rand has repeatedly stated that once upon a time the dollar was backed by gold, then Treasuries, and now home loans and car loans. This is an important recognition for a return to sound money.

    Lastly, Ron has repeatedly made the case that the Constitution puts the monetary power with Congress. Rand is being consistent with Ron's constitutionalism.

  5. Speaking of tangents, any timeline yet on when Rand is going to respond to our questions from the other week?

  6. --" In fact, the Fed has $4.5 trillion in assets, mostly Treasury bonds and mortgage-backed securities guaranteed by the Federal government."--

    In other words, he calls what amount to IOUs from liars and cheats "assets."

  7. It may be that the uSA Congress with the oversight of the FedRes is a bad idea but it is more Constitutionally faithful. Not that the FedRes is going away anytime soon.