States House of Representatives, Committee on Financial Services,
Subcommittee on Domestic Monetary Policy and Technology, Hearing
on "Federal Reserve Aid to the Eurozone: Its Impact on the
U.S. and the Dollar", March 27, 2012
Reserve has recently begun to engage in an ongoing bailout of the
European monetary system. Under the guise of providing dollar liquidity
to strained European financial markets, the Fed is creating hundreds
of billions of dollars out of thin air to prop up the euro. While
still well under their 2008 peak, these latest dollar swap agreements
are nonetheless a thinly-disguised bailout. Congress has been far
too lenient in allowing the Fed to engage in unprecedented monetary
policy operations without informing or explaining its actions to
Congress. The American people need to understand the effects these
actions have on the dollar so that the Fed can be held accountable.
I hope that this hearing will get much-needed answers to the very
important questions surrounding the Fedís involvement in bailing
For over 40
years, the Fed has been creating money out of thin air, propping
up Wall Street while destroying the value of the dollar. This excessive
money creation is what caused the financial crisis, yet just as
a dog returns to its vomit, the Fed thinks that continuing to print
money will somehow end the crisis. The trillions of dollars the
Fed has created have eviscerated the purchasing power of American
consumers, as anyone who has set foot inside a grocery store can
see. While the government's official inflation rate is hovering
around three percent, the original method of calculating the price
index indicates that price inflation is over ten percent, which
is more in line with what consumers are experiencing.
Despite a world
awash in dollars, the Fed continues to view the cause of every financial
problem as a dearth of liquidity. When the banks say they do not
have enough money, the Fed unquestionably believes them and provides
them with new dollars created from nothing. But a bank saying that
there is not enough money is like a broke college student saying
that there are not enough Ferraris. What he really means is that
there are not enough Ferraris for sale at a price that he can afford.
The same is true with banks; there are plenty of dollars available
for banks to borrow, but the banks don't want to pay the going interest
rate on loans, so they run to the central bank for cheap money.
Much of the
Fed's intervention in the U.S. has been undertaken in an attempt
to reflate the housing market. Rather than allowing house prices
to fall so that supply and demand will re-equilibrate, the Fed has
pumped liquidity into the system in an attempt to keep prices elevated.
The federal funds rate has been kept artificially low for over three
years now, and according to the Fed will be kept near zero for at
least three years more. Because the Federal Reserve is so used to
manipulating interest rates, it fails to see that interest rates
are a price, the price of money and credit. While American banks
may not be willing to lend dollars short-term to ailing European
banks at 0.25 or 0.50%, you can bet that there would be a lot more
dollars available to loan at 2, 3, or 4%. But in order for the markets
to adjust and price loans at a market-clearing rate, the Fed needs
to abstain from intervening to short-circuit this price discovery
Reserve has pumped trillions of dollars into the American financial
system, with banks now holding $1.5 trillion of excess reserves
at the Fed, money which is literally just sitting there. The Fed
pays an 0.25% interest rate on those excess reserves, which lessens
the incentive of the banks to loan those funds to anyone, regardless
of how safe the loan might be. This leads to a lessened availability
of credit both domestically and abroad, with the result that credit
markets are more contracted than they otherwise might be. The Fed
views this credit market contraction as having its root in insufficient
liquidity, which it then attempts to counteract by creating more
This time around,
the newly created dollars are being loaned through swap lines to
the European Central Bank (ECB) in exchange for euros. The ECB loans
the dollars to struggling European banks in exchange for collateral.
Once those loans are repaid and the swap lines expire, the ECB returns
the dollars to the Fed and takes back its euros. The interest rate
on these loans is about 0.6%, so it is not surprising that American
banks are keeping their excess reserves safe at the Federal Reserve.
After all, why loan dollars to weak and risky European banks at
0.6% when you can get a guaranteed 0.25% from the Federal Reserve?
So the dollar markets dry up and the Fed steps in to "fix"
the problem it created.
We have to
question what will happen if these loans from the ECB to European
banks go bad. What happens if a major bank fails? If the ECB cannot
return dollars to the Fed, does the Fed keep the euros it received
from the ECB? Does it receive European government bonds, perhaps
Greek bonds? Does it have recourse to the ECB's gold, as Chairman
Bernanke alluded to last week?
more importantly, what is the impact of these programs on the dollar
and on the U.S. economy? While the Fed seems to think that these
swap lines eventually will be drawn back down to zero, what happens
in the meantime? These hundreds of billions of dollars may be created
out of thin air, but their effects on the real economy are anything
but ephemeral. And the Fed has failed to consider the possibility
that these swap lines may rise even higher than the $600 billion
level that was reached in 2008. Given the still precarious position
of European governments and the European financial system, it would
not be surprising to see a few hundred billion dollars more being
created to continue the bailout of the euro.
The Fed's continued
intervention in financial markets creates a climate of uncertainty.
For almost five years, financial institutions have had to wonder
from one day to the next what the Fed will do. Will it continue
with more asset purchases under its policy of quantitative easing?
Will it bailout large firms in danger of collapse or allow them
to fail? Will it allow markets to function or continue its intervention?
In such uncertain times it is only natural for firms to sit back
and wait to see what happens. And every action by the Fed, every
attempt at stimulus, rather than placating that uncertainty, instead
exacerbates it. The Fed's actions destroy markets, erode the earnings
and savings of Americans, and sow the seeds for the next great crisis.
I hope that this hearing is yet another step in holding the Fed
accountable and will help both Members and the American people reconsider
the necessity of a central bank.