Question 1: When the FOMC purchases treasury bonds and releases money into the market I believe it then goes to the various lending institutions that formerly held the treasury bonds. If I am correct in this assumption, it leads me to wonder if that money is subsequently subjected to the credit expansion effect (10x) discussed in Jesus Huerta 's Money, Bank Credit, and Economic Cycles? And if this is the case why do we never hear of the Fed restricting the money supply by huge numbers when they determine to raise the Federal Funds Rate?Question 2: This one refers to some of Ron Paul’s more intriguing rhetoric. He often discusses the debasement of the US dollar through the Fed printing off money. I understand the mechanics of how this debasement happens, and I understand how FOMC operations can produce the consequences he speaks of. What I’m not familiar with is the Fed printing off money to pay bills. It’s not surprising that this wouldn’t be widely advertised in the media, but is there somewhere that I could read about this happening? I imagine this is different than the FOMC manipulating the FFR? Do we have, as an example, a tally of the amount printed off and what it went to pay for? Or is it an entirely clandestine process?
I would be very grateful for any responses to these questions.
Question 1: The Fed often purchases treasury bonds directly from the government, upon issuance. Otherwise, it purchases them on the open market. They may be held by institutions, individuals, foreigners, etc.
Question 2: The Fed doesn’t print money to pay bills. The Fed doesn’t technically print money at all. Money created by the Fed (whether printed by the Treasury or left in electronic form) arises from debt – not “nothing.” In fact, debt is less than nothing. So when Ron Paul says “the Fed prints money to pay off the government’s bills,” what he means is that it creates money to purchase the bonds with which the government pays its bills. It creates the money out of the government’s debt.
I should elaborate slightly … I still assume even if the money doesn’t go directly to lending institutions that it ultimately finds its way into those lending institutions, as de Soto suggests it would in his analysis of the credit multiplier…
The government may produce Treasury bonds (and other debt instruments) “at will,” limited only by the budget passed by Congress, I think. It produces the bonds, and then “lenders” (bond buyers) bid on the interest rate they will accept for those bonds. Of course, the Fed plays a major role in this, buying more than 1/3 of the bonds. The government thus pays interest to the Fed, but the Fed turns around and gives its profits to the Treasury – so in a very real sense, the government is simply printing money to pay its obligations.
When the FOMC sells from its inventory of government bonds, the effect is to contract the money supply, thus raising the Federal Funds Rate. I’m guessing your question is more intricate than my answer, but as I understand it, yes, this would result in the reversal of the previous credit expansion.