Aren’t we making too big a deal about the Fed’s balance sheet?

The Federal Reserve does not “print money” to “earn” the debt of the US Treasury. The view assumes that a creation of the federal government could finance the same government.

If the Treasury relied on the Fed’s so-called “printing press” to stay afloat, then the Treasury would have no debt. This is because no one buys income streams from the Treasury, rather cautious investors buy income streams from the US Treasury for what they can be exchanged for: think real resources such as trucks, tractors, buildings, computers, paper clips, copy paper and most important of all, labor.

Some will ask how – if it doesn’t print and hasn’t – the Fed has built up such a large collection of interest-bearing assets since 2008. All this time the Fed has been paying banks interest on their reserves, only to exchange those reserves for safe, interest-bearing assets. Saving for saving.

The obvious question from this is why banks would ever rent money to hold at the Fed. Furthermore, no bank ever sets aside money that could produce returns, so why is the Fed the proverbial warehouse? In the answer we can see why so many (or perhaps so few) were against bailouts in 2008. The banks that were bailed out were shy, which meant the Fed was a safe place to get a risk-free return on the money they controlled.

From this, is it any surprise that “private credit” and other forms of risk-focused lending have taken off? With banks, some of which were staring death in the face, withdrawing all but the safest lending (low interest rates were paradoxically a sign of difficult bank lending conditions), the riskiest lending or “systemic risk” simply found a new address, far away from the terrorist banks and regulators still haunted by what had happened.

Back to the Fed’s balance sheet, why don’t other central banks, like Argentina’s Banco Central de la Republica Argentina, have large balance sheets? See above. Governments prone to “printing” or persistent devaluation (yes, devaluation is the ONLY inflation) have very little debt. The markets for money are ruthless, the power of compounding is overwhelming, which means printing is the way to go for very little debt issuance.

The US is obviously different. Its banks are and have been loaded with massive amounts of dollars that are the result of real production, which means the Fed paid and is paying interest on real savings. Balance sheet expansion was the matching of saving with saving. What is the point.

Not only is the Fed not printing, but its ability to expand its balance sheet was and is the result of buying income streams that are in high demand and would be in high demand even if the Fed were not a buyer. In other words, absent the Fed as a buyer, it would still have purchased the size of these income streams from the Treasury.

This is not meant to justify replacing the Fed with the market in the matter of liquidating widely held and trusted asset positions, but it does mean that the benefit from this whole market is arguably not as unpleasant as many believe. Just because the Fed was buying what the rest of the market would have bought without the Fed, disposing of the same assets will not be as difficult as it is supposed to be.

In fact, it is what the trading desks at Goldman Sachs and other institutions do all the time, as in expertly and quietly selling large positions. If the Fed’s balance sheet is the problem, and the latter is probably overvalued, the size of its balance sheet is an indication that there will be a large market for what it holds.