Where the Fed gets its money

An astute reader over at MSNBC wondered where the Federal Reserve actually gets its money, meaning the cold, hard cash it is using to bail out Wall Street.  The basic balance sheet of the federal government is summarized nicely at the blog Econobrowser.  Essentially, what the Fed is doing is trading cash for assets.  How is that any different than you buying a lawnmower or a car or a nice pair of shoes and getting yourself into hock as a result?  Um… it isn’t.  The Fed is simply betting that it will be able to turn around and sell these assets (or recoup their value in some manor) later on.  But, as is pointed out in the above MSNBC article, that implies that they have some sort of “exit strategy.”

But do they?  Even if McCain wins the election, how many more years will Bernanke and Paulson be on the job?  Are either one of them really thinking ten or twenty years in the future since, I’m guessing, ten years is a minimum time frame for recouping their losses?  (That’s a complete guess, by the way – pulled entirely out of my ass.)  Probably not.  Human beings have never been very good at very long-term planning.  Perhaps there’s some evolutionary or genetic reason for it.  In any case, the Fed is taking a huge gamble.  Assets like real estate are at least tangible (take heart, homeowners – there’s a finite amount of land on this planet and a growing population).  But, ever since the end of the gold standard, money is backed by nothing more than “full faith and credit” of the US government (read any greenback in your wallet – that is if you have any in your wallet).  Um… yeah, that doesn’t instill a whole lot of confidence in me.  In other words, a lot of paper assets are not backed by anything tangible anymore and thus wealth can literally vaporize into thin air.  Of course, the Fed is essentially self-sustaining in that they don’t need to beg for money from Congress since they make a small fortune from selling bonds.  But these are once again backed by nothing more than good faith.  Unfortunately an awful lot of people have lost faith in the financial system recently and that could be a problem.  I just wonder if the Feds thought of that.

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