What is Happening to the “Full Faith and Credit of the United States?”

George Schultz, a man who has seen a few things in his day, and his team at the Hoover Institution, ask this question in Sunday’s Wall Street Journal.

They warn that Americans can’t count on global crisis to force people to the supposed safe haven of the dollar. Those in charge of the dollar have been reckless and the world knows it. The world is looking for an exit from the greenback trap.

The economic situation is as bad right now as it has ever been in the history of the United States. It is not the most acutely painful moment in the history of the United States right now, but we are jacked up on “monetary morphine.”

(From The Wall Street Journal)

Did you know that, during the last fiscal year, around three-quarters of the deficit was financed by the Federal Reserve? Foreign governments accounted for most of the rest, as American citizens’ and institutions’ purchases and sales netted to about zero. The Fed now owns one in six dollars of the national debt, the largest percentage of GDP in history, larger than even at the end of World War II.

The Fed has effectively replaced the entire interbank money market and large segments of other markets with itself. It determines the interest rate by declaring what it will pay on reserve balances at the Fed without regard for the supply and demand of money. By replacing large decentralized markets with centralized control by a few government officials, the Fed is distorting incentives and interfering with price discovery with unintended economic consequences.

Did you know that the Federal Reserve is now giving money to banks, effectively circumventing the appropriations process? To pay for quantitative easing—the purchase of government debt, mortgage-backed securities, etc.—the Fed credits banks with electronic deposits that are reserve balances at the Federal Reserve. These reserve balances have exploded to $1.5 trillion from $8 billion in September 2008.

The Fed now pays 0.25% interest on reserves it holds. So the Fed is paying the banks almost $4 billion a year. If interest rates rise to 2%, and the Federal Reserve raises the rate it pays on reserves correspondingly, the payment rises to $30 billion a year. Would Congress appropriate that kind of money to give—not lend—to banks?

Click here for the piece.