Opinion Editorial | |
| Monday, October 11, 1999 | |
How The Federal Reserve Creates Money |
The Federal Reserve, America's central bank, is a mysterious institution to most people. However, one would expect a member of the House Committee on Banking and Financial Services, which oversees the Fed, to be reasonably knowledgeable on the subject. But sadly, this is not the case. At least one member of this committee, Congressman Jack Metcalf, Republican of Washington, seems to have no clue at all.
Lately, Metcalf has taken to making speeches on the House floor complaining about the "tax" that Americans are assessed for using Federal Reserve notes. Says the congressman, every American is paying $100 per year just to get the cash they spend. Better the Treasury should issue this money, he believes, and the Federal Government would save $25 billion per year. "This is not rocket science," he says.
What the confused congressman is talking about is the fact that the Fed conducts monetary policy by buying and selling U.S. Treasury securities. When it buys the money supply expands, when it sells the money supply contracts. The vast bulk of the money that is created in the process consists of bank balances. Only a tiny percentage involves the actual printing of currency, which in fact is done under contract for the Fed by the Treasury's Bureau of Engraving and Printing.
As a consequence, the Fed has come to own a big chunk of the federal debt. As of June 30, it held $494 billion in Treasury securities on which it is paid interest. Last year, the Fed received $26.8 billion in interest from the Treasury. This is the tax that Congressman Metcalf is upset about. But what he fails to note is that the Federal Reserve sends virtually all of this money back to the Treasury and it is counted as revenue to the government (see figure). In 1998, the Treasury got a check from the Federal Reserve for $24.5 billion. The difference goes to pay for Federal Reserve operations and salaries.
So there really is no tax, as Metcalf asserts. It is just a bookkeeping transaction, with the money going out of one of the Treasury's pockets and coming right back around into its other pocket. Taxpayers would save nothing by converting Federal Reserve notes to Treasury notes, as Metcalf believes.
If the congressman wants to be useful, he should look into the Federal Reserve's expenses, which ultimately do come out of the taxpayer's pocket. An article in the August 2 issue of Barron's details the sharply rising cost of operating 12 regional Federal Reserve banks that don't really serve any necessary purpose in today's economy.
Source: Bruce Bartlett, senior fellow, National Center for Policy Analysis, October 11, 1999.
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