The federal government and income taxes.

[The Operative]

Steve,

The government doesn't borrow money from the Fed because the Fed buys the securities it holds ON THE OPEN MARKET.

U.S. Government sells Treasury securities at auction. Joe Schmo buys a few $1,000 T-Bonds at the auction. Government will not redeem the bonds before maturity date. A couple of years after buying the bonds, Joe Schmo decides to sell them for whatever reason, so he has a broker offer them for sale on the secondary market. The Federal Reserve, looking to expand the money supply, buys the bonds on the open market. Yes, the Federal Reserve now holds the note, but the money the government received for those bonds came from Joe Schmo and not the Federal Reserve.

As I mentioned in the previous paragraph, when the Federal Reserve is looking to expand the money supply (or adjust certain interest rates), it buys bonds on the open market. Yes, it does create money out of "thin" air when it does this. Basically, the Federal Reserve contacts a group of brokers for the purchase of the bonds. Whichever broker(s) provide the best deal, the Fed authorizes them to complete the transaction. The account of the broker's bank at the Federal Reserve is then increased by the amount of the transaction. So, if the Fed buys $20 billion of Treasury securities on the open market, and the brokers account is with Bank of America, then Bank of America's account at the Federal Reserve is increased by $20 billion (which is a liability of the Fed) and in return the Fed receives $20 billion in Treasury securities (an asset for the Fed).

BTW, the Fed destroys money into 'thin' air also. If the Federal Reserve wants to decrease the money supply (or adjust certain interest rates), it sells bonds on the open market. Again, the Federal Reserve contacts the brokers and shops for the best deal. Once the transaction is completed, the Fed delivers the bonds and the brokers deposit the money at their bank (i.e. Bank of America). The Fed reduces the bank's (i.e. Bank of America) holdings at the Federal Reserve and the money is gone into thin air. The bank's holdings at the Fed are a liability and it is decreased and the level of assets (i.e. Treasury securities) is also decreased.

BTW, Steve, October still comes before December. Also, the 16th amendment, which was passed by Congress with the intention of enacting an income tax shortly after it was ratified, was passed by Congress in 1909. EDIT: The Civil War income tax was from 1862 to 1872 (that's 10 years) with the first income tax law enacted in 1861. Congress basically enacted a new income tax law every couple of years during that time.

[SteveSy]

As I mentioned in the previous paragraph, when the Federal Reserve is looking to expand the money supply (or adjust certain interest rates), it buys bonds on the open market. Yes, it does create money out of "thin" air when it does this. Basically, the Federal Reserve contacts a group of brokers for the purchase of the bonds. Whichever broker(s) provide the best deal, the Fed authorizes them to complete the transaction. The account of the broker's bank at the Federal Reserve is then increased by the amount of the transaction. So, if the Fed buys $20 billion of Treasury securities on the open market, and the brokers account is with Bank of America, then Bank of America's account at the Federal Reserve is increased by $20 billion (which is a liability of the Fed) and in return the Fed receives $20 billion in Treasury securities (an asset for the Fed).

They also engage in outright buys. How do you think the brokers get the bonds? You don't think the very entity tasked with handling the open market operation has the ability to purchase the securities like the brokers? One thing to note is that the FED holds all of the information so there's just numbers being shifted around. No bonds or bills are actually transferred.

Besides it really makes no difference if the FED buys from a third party on the open market or direct, its all the same the FED is lending the government the money. If there are no buyers the government doesn't sell its debt.

[The Operative]

As I mentioned in the previous paragraph, when the Federal Reserve is looking to expand the money supply (or adjust certain interest rates), it buys bonds on the open market. Yes, it does create money out of "thin" air when it does this. Basically, the Federal Reserve contacts a group of brokers for the purchase of the bonds. Whichever broker(s) provide the best deal, the Fed authorizes them to complete the transaction. The account of the broker's bank at the Federal Reserve is then increased by the amount of the transaction. So, if the Fed buys $20 billion of Treasury securities on the open market, and the brokers account is with Bank of America, then Bank of America's account at the Federal Reserve is increased by $20 billion (which is a liability of the Fed) and in return the Fed receives $20 billion in Treasury securities (an asset for the Fed).

They also engage in outright buys. How do you think the brokers get the bonds? You don't think the very entity tasked with handling the open market operation has the ability to purchase the securities like the brokers? One thing to note is that the FED holds all of the information so there's just numbers being shifted around. No bonds or bills are actually transferred.

Besides it really makes no difference if the FED buys from a third party on the open market or direct, its all the same the FED is lending the government the money. If there are no buyers the government doesn't sell its debt.

First, the government doesn't deal in the open market (aka secondary market). The government only sells the debt it wants to issue at auction. The Fed doesn't buy securities at auction. It buys the securities it holds on the open market. Regardless of whether the Fed buys the securities through a broker or directly is practically irrelevant because the money, when the Fed makes a purchase, is created by the Fed and goes to the seller. Same thing when the Fed sells securities, the money comes to the Fed from the buyer and is destroyed into 'thin' air.

Second, even if we accept your definition that the Fed is lending the government money, what is the big deal? Since the Fed returns excess earnings to the U.S. Treasury, it is actually cheaper for the U.S. Government to "borrow" from the Fed than from anyone else. In 2007, the Federal Reserve collected $40.3 billion in interest on the $745.6 billion in Treasury securities it was holding. After expenses and the dividends ($992 million) were paid to the member banks, the Federal Reserve returned $34.6 billion to the U.S. Treasury. So, that is $5.7 billion in net interest on $745.6 of debt. That is an interest rate of 0.76%. I want that rate for my loans.

Disclaimer: This is a necessarily simplified explanation of an extremely complex topic.

[SteveSy]

Second, even if we accept your definition that the Fed is lending the government money, what is the big deal? Since the Fed returns excess earnings to the U.S. Treasury, it is actually cheaper for the U.S. Government to "borrow" from the Fed than from anyone else. In 2007, the Federal Reserve collected $40.3 billion in interest on the $745.6 billion in Treasury securities it was holding. After expenses and the dividends ($992 million) were paid to the member banks, the Federal Reserve returned $34.6 billion to the U.S. Treasury. So, that is $5.7 billion in net interest on $745.6 of debt. That is an interest rate of 0.76%. I want that rate for my loans.

Disclaimer: This is a necessarily simplified explanation of an extremely complex topic.

Because its extremely inflationary....its simply printing money.

btw, all this baloney about how good of a deal the government got is nonsense. They're creating the money they're lending out of thin air! It would be like you going to Fat Fred asking to borrow 100k and he's says sure, I'll even cut you a good deal at .76% interest, next he pushes a button and 100 dollar bills starting coming out of his press. Worse actually, at least Fred has to pay for ink and paper.

Now the FED is doing something even worse, they're buying long term securities. Something they've never done before. They're trying something no other country has tried. They're trying to beat deflation, something that happens right before a major depression, by intentionally causing inflation. Do you realize what that could do if it fails?

Watch, Foreign countries are going to rapidly move away from long term securities, because they know we're really screwing up bad, and make their purchases in short term. The government is, I should say we are, in a real pickle. If it fails, which a lot of people think it will, it will happen extremely fast and there will be no fixing it whatsoever.

[GoldandSilverEagles]

It doesn't make sense because it is complete nonsense. The power to regulate the money supply (or the total amount of money available in an economy) is a power granted to the legislative branch which has delegated that power to the Federal Reserve with some oversight. The government cannot simply print all the money it needs. That is a sure fire recipe for runaway inflation (i.e. Zimbabwe). The Fed attempts to control the money supply through interest rate adjustments and open market operations in order to maintain an adequate supply of money to encourage growth yet keep inflation at a decent level. This is a balancing act, the details of which are much too broad a topic to cover in an online forum.

As I have said before, the government does not borrow from the Federal Reserve. The government borrows money by issuing government securities. These are T-Bills, T-Notes and T-Bonds. These securities are sold at auction on the steps of the New York Federal Reserve district bank. Anyone may buy these securities, even you.

Treasury or government securities are issued with maturity dates and the government will not redeem them until their maturity date. So, if a person purchases a five-year T-Note at auction, they cannot get the money they loaned to the government until the maturity date. However, they may sell the T-Note to someone else on the open market. The open market (aka secondary market) is also where the Federal Reserve purchases the Treasury securities that it owns. The Federal Reserve uses open market operations to affect a key interest rate and to make adjustments to the money supply. Again, this is too broad a topic to cover adequately in an online forum.

Hmmm...so the fed reserve buys the FRN's from the bureau of printing and engraving for the cost of printing (about 3-4 cents per note regardless of face value) and in turn uses said notes to "buy"/trade/barter for government securities, if i understand you correctly. That would enable the fed reserve to buy securities at the ratio of 100$ face value for 3-4 cents each! Now if I understand this correctly that's one hell of a sweet deal! Any idea how I can get in on that myself? Lol...

[The Operative]

It doesn't make sense because it is complete nonsense. The power to regulate the money supply (or the total amount of money available in an economy) is a power granted to the legislative branch which has delegated that power to the Federal Reserve with some oversight. The government cannot simply print all the money it needs. That is a sure fire recipe for runaway inflation (i.e. Zimbabwe). The Fed attempts to control the money supply through interest rate adjustments and open market operations in order to maintain an adequate supply of money to encourage growth yet keep inflation at a decent level. This is a balancing act, the details of which are much too broad a topic to cover in an online forum.

As I have said before, the government does not borrow from the Federal Reserve. The government borrows money by issuing government securities. These are T-Bills, T-Notes and T-Bonds. These securities are sold at auction on the steps of the New York Federal Reserve district bank. Anyone may buy these securities, even you.

Treasury or government securities are issued with maturity dates and the government will not redeem them until their maturity date. So, if a person purchases a five-year T-Note at auction, they cannot get the money they loaned to the government until the maturity date. However, they may sell the T-Note to someone else on the open market. The open market (aka secondary market) is also where the Federal Reserve purchases the Treasury securities that it owns. The Federal Reserve uses open market operations to affect a key interest rate and to make adjustments to the money supply. Again, this is too broad a topic to cover adequately in an online forum.

Hmmm...so the fed reserve buys the FRN's from the bureau of printing and engraving for the cost of printing (about 3-4 cents per note regardless of face value) and in turn uses said notes to "buy"/trade/barter for government securities, if i understand you correctly. That would enable the fed reserve to buy securities at the ratio of 100$ face value for 3-4 cents each! Now if I understand this correctly that's one hell of a sweet deal! Any idea how I can get in on that myself? Lol...

You did not read the explanation correctly. Also, the securities are not usually purchased using printed bills. Federal Reserve notes are LIABILITIES of the Federal Reserve. If they were used in the method you describe, they would be assets and FRNs are not assets of the Federal Reserve. Again, this is an extremely complicated topic and for a full discussion would take much more than a few posts on an Internet forum.

[SteveSy]

Hmmm...so the fed reserve buys the FRN's from the bureau of printing and engraving for the cost of printing (about 3-4 cents per note regardless of face value) and in turn uses said notes to "buy"/trade/barter for government securities, if i understand you correctly. That would enable the fed reserve to buy securities at the ratio of 100$ face value for 3-4 cents each! Now if I understand this correctly that's one hell of a sweet deal! Any idea how I can get in on that myself? Lol...

No, actually its worse. They just credit the sellers account for the securities. Poof $X magically created, it costs nothing. The FED has a liability on their account which is also created out of thin air, which btw has no due date. But like he said the money can just as easily disappear also if the FED sells the security. The buyers account is decreased by the amount of the security and the FED's liability is eliminated. Of course the FED doesn't have to eliminate its liability, its their option.

FRN's and government securities are reserves for banks. Banks holding these have a 10% reserve requirement . With 100k in reserves banks can lend up to $1,000,000. So not only has the FED created the money out of thin air to buy the initial security they then can use it to lend it to member banks who then can lend 10x more. The formula is: Money Created = Reserves on hand x (1 / .10)

So when the FED buys up 300 billion in long term securities, like they're doing now, they're actually allowing 3 trillion to be printed.

Isn't the world of monetary policy wonderful?

[Gregg]

I don't think some people are getting it. As someone said, it's EXTREMELY COMPLICATED, but in short, the job of the Fed is to match the money supply to what backs it (and that is not thin air, it's the value added by economic activity). Worker goes in for the day, takes $50 worth of raw materials and works them to a product worth $1000. He gets paid $450 for the day's work. The "money supply" has thus been increased by $500. This economic growth is what backs Federal Reserve Notes in the end. (not really, tax revenues from it does, but you get the gist)

Easy so far? The complicated part is that the Fed's actions don't have immediate effect, and their data they base the action on is lagging. So they make decisions for 3 months from now, based upon data 3 months old. But in the end, the simplified version is they control the money supply based upon trying to increase or decrease it to match the level of new value created by aggregate activity in the economy.

Also, just a point, the Federal Reserve Banks are private corporations, not owned by the super secret Illuminati overlords (we have other methods) but by the Banks that participate in the system (something they are not required to do). The Federal Reserve Board is a Government entity, but not the same as the Banks. When I was in school I worked (slaved is more like it, I was an intern) for the Cincinnati Branch of the Cleveland Federal Reserve Bank, mostly what I did was contact a list of companies every week and compiled data that was made into reports for the important people to use. How many employees on the payroll, how much spending on new equipment and stuff like that, none of which is important in itself but assuming hundreds of people like me were working on the same things, a pretty impressive picture of what is going on can be made.

Fascinating stuff, but all the conspiracies theories about the evil Fed just make me laugh, trust me kids, you WANT the Fed to do pretty much exactly what it does, if it didn't it would affect the poor far far more than it would the rich.

[SteveSy]

Worker goes in for the day, takes $50 worth of raw materials and works them to a product worth $1000. He gets paid $450 for the day's work. The "money supply" has thus been increased by $500. This economic growth is what backs Federal Reserve Notes in the end. (not really, tax revenues from it does, but you get the gist)

That doesn't make any sense to me.

How is the "money supply" increased? That item is then sold to a consumer who pays the $1000. $1000 is credited to the manufacturers account and the buyers account is decreased by the $1000, its a wash.

I will agree that the value of our money, the reserves, is in theory tied to production because more production means more tax meaning more bonds can be issued against potential revenues. We have a massive trade deficit, meaning our production is outsourced. If we buy $1000 worth of goods from China and we only sell $50, that means we had to borrow $950 to buy that $1000 in goods.

[Judge Roy Bean]

Worker goes in for the day, takes $50 worth of raw materials and works them to a product worth $1000. He gets paid $450 for the day's work. The "money supply" has thus been increased by $500. This economic growth is what backs Federal Reserve Notes in the end. (not really, tax revenues from it does, but you get the gist)

That doesn't make any sense to me.

How is the "money supply" increased? That item is then sold to a consumer who pays the $1000. $1000 is credited to the manufacturers account and the buyers account is decreased by the $1000, its a wash.

I will agree that the value of our money, the reserves, is in theory tied to production because more production means more tax meaning more bonds can be issued against potential revenues. We have a massive trade deficit, meaning our production is outsourced. If we buy $1000 worth of goods from China and we only sell $50, that means we had to borrow $950 to buy that $1000 in goods.

It's already been pointed out that there isn't room (nor attention span) to slog through money supply and the theories behind its effects; all those people with initials after their names can't agree on anything, anyway.

"Value" is magically created whenever some entity produces something that some other entity wants and is willing to pay for - often at some unspecified future date. If sufficient money isn't in the supply, lenders will pay more to obtain it and thus borrowers will pay more to use it, which is the delicate dance of managing the money supply and interest rates.

The days of business not making something until it's been paid for have gone the way of the dinosaur because of centralized banking and the ready availability of credit toward future payment. It has had its destructive side effects on consumers because of usurious practices, but by and large, for well-run businesses it's a necessity, not just a convenience.

[SteveSy]

"Value" is magically created whenever some entity produces something that some other entity wants and is willing to pay for - often at some unspecified future date. If sufficient money isn't in the supply, lenders will pay more to obtain it and thus borrowers will pay more to use it, which is the delicate dance of managing the money supply and interest rates.

I don't believe this has anything to do with "money supply" rather its a supply of credit. Those aren't necessarily the same, as we see now. If simply putting a lot of money in supply is the key to success then Zimbabwe would be one of the richest nations on Earth.

If the money supply is limited then deflation takes place. Deflation isn't necessarily a bad thing, its bad when its a product of a lack of economic activity. You can have price deflation as a result of a limited money supply and still have a strong economy. For instance wages and the price of products can drop by 25% due to the lack of available money. What's happened is money has just increased in value. Its a simple supply and demand issue. Money is really no different than any other commodity, it is tied to the same laws of economics.

The FED can attempt to manipulate the rules through monetary policy but the jury is still out whether their policies can withstand the test of time. Interest rates are near zero, and money is being created hand over fist, yet no credit is available. All that has happened is the FED has just delayed the normal cycle of economics in the past by continually piling all of the negatives on the future to deal with via debt. Wages and consumer prices have to continually increase to counteract the inflation created by all the money created and debt must grow exponentially. Well, the future is here, their tools don't work anymore. Most importantly they're having a very hard time getting countries to buy the debt which is a fundamental component to keeping the scheme working. Foreign countries see the writing on the wall and realize the debt is so high the government will have a very difficult time servicing it.

If you want to see what's going to happen just keep an eye on Britain, they can't sell their securities (gilts) and now they're on a fast track to collapse.