So I came up with this, and I wondered what exactly would be the problem?
Let’s say the treasury creates some debt in order to fund a banana stand. They need $1 million. The Fed prints $1 million and purchases all of the debt. Then the government actually turns a profit on the banana stand (I know, would never happen, but just for the sake of argument). The Fed then gets their $1 million back plus their profits from interest. They destroy the $1 million and the profit is returned to the Treasury. Where is the malinvestment in this situation?
(Note that I’m not a fed supporter, just a little uneducated on the subject).
They’ve made enough money back from the profits of the banana stand and have saved enough money that they don’t need loaned money from the Fed anymore.
The Fed loaned $1Million. The revenue from the banana stand is $1.1Million for a 10% accounting profit. Part of that is interest. For example, if the interest was say 10%, then all of the profit is interest. In any event the $1.1 Million or close to that amount is paid back to the Fed.
But now you are back to where you started. No capital! You need to reinvest $1 Million again in the hope of reaping another profit in the future.
But here is the part that makes no sense. Say that the banana stand then just closes down. A profit is made, the capital that was “loaned” from the Fed is given back and that money destroyed. Capital was given to them though, so where is the negative effect? Who am I ignoring in this example?
What is unseen is where the resources allocated to the banana stand would have gone otherwise, and at what price. We must not neglect the fact that price structure for land, labor, and whatnot must have been altered by the funny money banana stand. This will impact those in the market for such resources (some of whom must have real savings).
If the stand is created and then destroyed, then it’s hard to imagine how such a “business” venture could be beneficial since resources were diverted from other ventures to meet this one time venture.
Change the example a little bit to make it more realistic.
Assume the Fed reinvests the $1 Million after it gets paid back for as long as the stand is profitable.
So what happened? The Fed’s new money originally diverted resources from other business ventures to set up its banana stand and found out that its investment is actually profitable. So the Fed has made a successful entrepreneurial decision, or at least not as bad as it could have been. He got lucky!
I told you what capital has been affected: the storefront, cash register, light bulbs, banana stand uniforms, labor, etc. Must not forget land, too: bananas, the ground upon which the banana stand stood, the wood used to build the banana stand, etc.
In this example, malinvestment happens when the venture bids away resources from other ventures with Fed supplied credit. The moment the Fed stops financing the venture, and as a result the enterprise shuts down, then the malinvestment stops.
Suppose there are only 2 banana stands in the economy, for sale for 100,000$ each. Through my hard efforts, I have saved up 100,000$ to invest in a banana stand business. Then the government borrows 1 million from Fed and purchases the two banana stands. My capital is now no longer enough to invest into a business.
My saving and investing has been punished, while the inflating of the government has been rewarded. This increases time preference and produces decivilization.
Yes, now that makes sense. The money is used to buy real products, and when that happens they take the money away from what are more worthwhile ventures. Got it. Thanks.
The Federal Reserve earns interest on the Treasury securities it holds every year. The Federal Reserve pays any operating expenses and after that, they return most of that interest BACK to the US Treasury every year, the majority remaining amount is put into a surplus fund and the rest, about 2% of the interest in 2006, is paid to the federal reserve banks as dividends. In actuality, the net-interest cost to US taxpayers is close to ZERO, seeing as the FED sometimes even transfers more than the amount they received in interest to begin with.
How is that no net cost? They inflate the money supply to pay for the treasury. That’s a cost to all of us in terms of lower value of our money.
You can’t get these debts paid for by printed money and expect no negative benefit on all of us. There is inflation. Even in the best example that I could think of for a case was this not true. There is always a negative cost to society when you try to pay debts with newly printed money.
the net-interest cost to US taxpayers is close to ZERO, seeing as the FED sometimes even transfers more than the amount they received in interest to begin with.
But the profit that the Fed earned by taking away the money of all of us does not necessarily exceed the profit that all of us collectively would have earned had the money been left with ourselves. In fact the whole problem is with looking at this in terms of money. Our goods are stolen from us. No other company can spend money for us better than we can. In fact, the profit that the Fed makes by stealing our money can never be more than the personal profits that we would have made had the money been left with ourselves. Even if the Fed doesn’t lose that money, there is still the lost opportunity cost.
You are describing a purely hypothetical scenario in which in Fed distorts the credit markets by injecting its new money, but after all the distortions have been corrected by the market, the Fed’s investment turns out to be a business success from the point of view of the consumers themselves. In such a situation, I don’t see how it is possible to say from a purely economic point of view whether the Fed’s business “investment” has improved the satisfaction of consumers any more or less then prior to its violent intervention.
I think that now we’re just getting confused. I’ve seen how the Fed lending that money and even getting that money back and destroying it does not maximize profit. Just because you have profit does not mean it was the best use of that money.