The Federal Reserve's Treasury Instrument Buying: A Deep Dive

The Federal Reserve's decision to buy $60 billion worth of Treasury bills each month raises several questions and concerns among investors and economists. This practice is far from just a standard monetary policy action but is deeply intertwined with broader financial dynamics and mandates.

Why Treasury Instruments?

Many might wonder why the Federal Reserve buys Treasury instruments rather than other asset classes such as equities, commodities, mortgage-backed securities, or commercial paper, let alone municipal debt. The primary reason is historical and practical:

Historical Safeguard: The US government has a long history of implementing sound fiscal policies, making Treasury securities a safe choice. However, this safety comes under scrutiny when considering broader economic and monetary factors. Trust and Credibility: The idea of the US government not defaulting in the traditional sense is solid. But, as we explore further, the concept of default is not as black and white as it appears. Macroeconomic Stability: Maintaining the stability of the US dollar and the US economy is critical, and Treasury instruments play a pivotal role in this stability.

The Role of Financial Repression

Financial repression, a policy that aims to keep interest rates artificially low to support economic growth, is closely tied to the Federal Reserve's actions. By buying Treasury bills, the Fed not only influences the yield curve but also helps to conceal the true cost of borrowing.

This financial repression has several implications: Deceptive Borrowing Costs: When interest rates are artificially low, the apparent cost of government borrowing seems lower, which can mislead fiscal policy assessments. Systemic Vulnerabilities: It can create a false sense of security, leading to overextended credit and potential economic crises in the future. Opportunity Costs: The low-interest environment can limit the returns on savings, negatively affecting citizens' financial health.

Mandate and Governance

The relationship between the Federal Reserve and the US government is complex and highly intertwined. The mandate of the Federal Reserve and its governors come from the US Congress, which includes key members with vested interests in supporting fiscal policies that benefit their constituents, often through low-interest loans.

This influence can be seen in the Fed's actions. For instance, the current high level of Treasury exposure could be a tool to drive down yields, concealing the true cost of borrowing and improving the fiscal performance metrics. This wholesale subsidy of the national debt is a form of financial repression.

The impact is more widespread, with the low interest rates supporting the economy in various ways but also distorting the natural market forces of interest rates, which can have long-term implications on economic health.

Implications and Concerns

While the status quo might appear stable, several concerns cannot be ignored: Public Deficit: The operating deficit before the pandemic was alarming, and the situation is even more complex today. Price Stability and Inflation: The current low inflation is above pre-fiat historical norms, which could lead to unintended inflationary pressures in the future. Economic Paradoxes: The perception of Treasury debt being so safe that no asset or revenue stream is needed for backing is a contradiction that demands scrutiny.

Conclusion

The Federal Reserve's massive purchases of Treasury instruments are a critical tool in managing the economy but also a reflection of broader fiscal and monetary policies. As we look towards the future, it is essential to critically evaluate these practices to ensure that they serve the broader economic interest and not just a select few.