Monthly Budget Review | March 2024

March 28, 2024
Featured image for “Monthly Budget Review | March 2024”
Actual FY 2023Preliminary FY 2024Y-O-Y Change
Source: Congressional Budget Office

The 2023 Annual Report of the Federal Reserve Bank was released in March and the results were unnerving.  The nation’s central bank lost $116 billion in 2023—that is, it paid out much more to its depositor banks than it received in interest on its bond holdings.  (Details follow at the end of this piece if you’re interested.)  The Fed’s shortfall stems from years of purchasing low-interest Treasury debt (in an attempt to keep rates down, also known as Quantitative Easing (QE)) combined with the present desire to raise short-term interest rates to combat inflation.  A similar liability mismatch led to the collapse of Silicon Valley Bank a year ago, and if the Fed were a commercial bank, the regulators would be hard pressed to avoid demanding that it raise additional capital or even be shut down. 

But the Fed is not a commercial bank.  It is in the business of keeping the banking system running smoothly, and has the awesome power of being able to create money without taking on any extraneous liabilities—its liabilities are money itself.  How it deals with those liabilities is a mere exercise in balance sheet accounting, for how can you go bankrupt if you have the power to create money?

Given this state of affairs, our readers might ask why the monthly commentary is even writing about this.  We do so only to make two points.  The first is that the Fed’s losses are caused by its payment of interest on bank reserves—a policy instituted as a result of Quantitative Easing, which led to an overabundance of bank reserves.  Essentially, the Fed is paying commercial banks the overnight rate (roughly 5.25 % as of this writing) on what are the equivalent of their checking account balances—a great deal more than the banks are paying their depositors to be sure.  This has been a guaranteed source of income for the banks and a godsend given the problems in commercial real estate.  One suspects that the Fed will be reluctant to end this backdoor bailout quickly.

The second point concerns the nature and method of funding the federal government.  As we have noted before, the Fed’s ability to create money is unlimited.  The question then arises as to why the federal government bothers with the trouble of selling debt and paying interest on that debt.

CBDC’s to the Rescue?

Readers may have a vague recollection of reading about proposals for Central Bank Digital Currencies (CBDC’s).  CBDC’s are purely digital money held in on-line accounts (think something like Venmo).  Their implementation could take a myriad of forms, but one might involve setting up an account for every American and placing balances in them.  Obviously, their success would depend on the willingness of people and businesses to accept and use them.  But if fully implemented, CBDC’s could offer a way out of the “debt spiral” which could constrain federal spending in the future..

Specifically, the adoption of a CBDC could bypass the current system in which Washington must pay interest on its debt.  Rather than exchanging new US government bills, notes, and bonds for money held or created by private economic actors—banks, mostly—the Federal Reserve could simply create non-interest bearing CBDC’s and deposit them in the Treasury’s account.  The Treasury could then use them to pay its obligations, and, over time, replace the current debt as it matured—leaving the deficit as nothing more than a line item on the Fed’s balance sheet.

We realize that suggesting the Federal Reserve could eliminate Washington’s debt and deficit problems with newly created money might lead readers to question our sanity, but it is true.  After all, the Federal Reserve created $116 billion last year to cover its losses—which it accounted for by the simple expedient of calling it an asset (Deferred Remittances to the Treasury) and placing it on its balance sheet – without anyone from Washington or Wall Street seeming to notice or care about it.

This is not to say that such a move would be without consequence—one might certainly expect it to touch off a bout of inflation—but rather that it could be done.  The decision to finance the government by the current method is a political one and not a market-imposed necessity. If federal government debt begins to constrain desired spending and/or demand significantly higher taxes, we might start hearing much more about CBDC’s.  A likely scenario would have them being issued as a “temporary” measure in a fiscal “emergency.”

From the Federal Reserve Bank FY 2023 Consolidated Income Statements

 (in $ millions)

GSE, net57,017
Total Interest Income174,525
Treasuries, Reverse Repos104,341
Depository Institutions176,755
Total Interest Expense281,096
Net Interest Expense106,571
Net Loss from Operations114,386
Earnings Remittances to the Treasury(116,063)
Federal Reserve Banks Combined Financial Statements as of and for the Years ended December 31, 2023 and December 31, 2022

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. 

The content is developed from sources believed to be providing accurate information.

Securities offered through LPL Financial, member FINRA/SIPC. Investment advice offered through Great Valley Advisor Group, a Registered Investment Advisor. Great Valley Advisor Group and Doylestown Wealth Management, Inc. are separate entities from LPL Financial.