If The Fed Loses Money, It Can Just Print More

Jan 30, 2013

A snake-eating-its-tail thing happens when you think certain thoughts about money and the Federal Reserve. A case in point comes courtesy of a story in this morning's WSJ.

Over the past few years, the Fed — which has the power to create unlimited quantities of money out of thin air — has created roughly $2 trillion. It used the money to buy bonds. The idea was to drive down unemployment by lowering interest rates and encouraging people and businesses to borrow and spend.

As a side effect, the Fed made tons of money from the interest on all the bonds it bought. It uses a little of the interest (a couple billion dollars a year) to fund its own operations. But the Fed turns the vast majority of the interest — $89 billion last year — over to the Treasury.

But the Fed could theoretically lose money, rather than make a profit.

When the economy finally starts improving, the Fed may raise interest rates and start selling off lots of the bonds it bought. When interest rates rise, bonds lose value. So the Fed may well sell lots of bonds at a loss. In fact, the Fed could lose more than $100 billion in the coming years, according to a new report (PDF) by Fed economists.

So if this happens, will the Fed have to go to the government and ask for a bailout?

No! It can just print more money!

Kevin Drum points out this detail in the WSJ story:

If the Fed were to record a loss, it could print its own money to cover its expenses—at no cost to the Treasury. The Fed would record a loss as a deferred asset, which would represent how much money the Fed would need to make up before it started sending profits to the Treasury again.

In other words, the Fed would basically use an accounting trick to say, "Sure, we lost money this year. But we'll make it back, and more, in the future. After all, we can print money."

Weirdly, this option may not have been open to the Fed until a just a couple years ago. Back in 2011, the Fed changed an arcane accounting rule (is "arcane accounting rule" redundant?) to ensure that it would never be forced to ask for a bailout.

FT Alphaville explained the rule change in amazing/excruciating detail. Free registration is required to read Alphaville, but if you're the kind of person interested in this kind of thing, registering for Alphaville will be worth your time.

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