Hummel on Fed Accounting
By David Henderson
Jeff Hummel has posted a careful analysis of the Federal Reserve’s recent change in accounting rules. His bottom line is that basically the change is no big deal. Although Jeff makes the case very carefully, as is his wont, it does get a little complicated. I had to read it twice. But here’s the final paragraph, for those who don’t have the time, that sums up his case:
In essence, the Fed functions–as do nearly all of the world’s central banks–like a giant legalized counterfeiter. It generates revenue the same way as any counterfeiter, by issuing money that imposes an implicit tax on the general public’s real cash balances. Therefore, it can no more be driven insolvent de facto than a successful, undetected, and illegal private counterfeiter. This is not to deny that Congress, having established the Federal Reserve System and the rules by which it operates, could decide that the Fed has somehow violated those rules and is nominally insolvent. But Congress can just as easily alter such rules to allow the Fed to continue operation. The future viability of the Fed, in short, is entirely a political decision, with absolutely no necessary economic relationship to any losses the Fed may suffer on its portfolio of assets.
Here’s an interesting paragraph that appears earlier in the piece:
Admittedly, pure fiat does not back up the entire monetary base. Both the Treasury and the Fed hold some genuine assets. For instance, the Fed still holds gold certificates, an asset of the Fed and liability of the Treasury, which in turn owns the actual gold at Fort Knox. The certificates are valued on the Fed’s balance sheet at the historical price of $42.22 on once. At current market prices, this asset would jump from $11 billion to around $340 billion, surely enough to cover a lot of Fed losses on other assets. I do not know whether the Fed could conduct such a revaluation entirely on its own authority or whether it would require the cooperation of the Treasury and Executive or even of Congress. But the ease with which this asset can be revalued, and the very fact that it does not show up in the Fed’s balance sheet at its current market value, underscores the ultimate irrelevance of Fed profits or losses.