Open Market Transactions

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md0's picture
md0
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Joined: Mar 10 2009
Posts: 3
Open Market Transactions


From What I understand, The treasury issues bonds. The fed might buy them. But the commercial banks are usually the ones who buy the bonds issued by Treasury. When it comes time to buy back the bonds and pay the bond holders the Treasury (with the help of the fed) does so (by our tax money).

I am confused about open Market Operations:

During open market operations:

1. The Treasuries on the Fed balance sheet - Where does the Fed get the money to buy them? Did they print money and buy them from the open market to increase the money supply?

2. Were these bonds originally issued by the Treasury to raise money for spending (wars, developement, etc)?

3. Does the Fed sell the same bonds to decrease the money supply and shrink its own balance sheet?

4. When the bonds are released back into the market (through open market transactions) is it the responsibility of the US Treasury to ultimately pay the bondholders? (I mean, the Fed decreased the money supply here, where does the Treasury get the money to pay from? I know they will raise taxes, but isn't the money destroyed by the Federal Reserve already?)


 

 

 

pleaseremoveme's picture
pleaseremoveme
Status: Silver Member (Offline)
Joined: Jan 24 2009
Posts: 115
Re: Open Market Transactions

I'm not really an expert, but I'll tell you what I think: 

md0 wrote:

1. The Treasuries on the Fed balance sheet - Where does the Fed get the money to buy them? Did they print money and buy them from the open market to increase the money supply?

 

Yup. It's the dominant way of bringing new money into circulation.

md0 wrote:

 

2. Were these bonds originally issued by the Treasury to raise money for spending (wars, developement, etc)?

 

Yup. Whenever governments make a deficit, they sell bonds as a way to get cheap credit.

md0 wrote:

  

3. Does the Fed sell the same bonds to decrease the money supply and shrink its own balance sheet?

 

Nope! It could sell bonds to decrease the money supply and shrink its balance sheet in theory, but I don't think they ever do that in practice.

md0 wrote:

  

4. When the bonds are released back into the market (through open market transactions) is it the responsibility of the US Treasury to ultimately pay the bondholders? (I mean, the Fed decreased the money supply here, where does the Treasury get the money to pay from? I know they will raise taxes, but isn't the money destroyed by the Federal Reserve already?)

There was some money to buy the bonds in the first place, before the FED bought them. That money is still around to pay back the bonds after the FED has sold them. But agian in practice, governments sell new bonds to pay back the old ones... 

 

 

 

BSV's picture
BSV
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Joined: Jan 26 2009
Posts: 170
Re: Open Market Transactions

The Fed is truly unique. When you or I write a check in payment of a debt, we are expected to have money in the bank to cover that check. If we do not, there are consequences. The Fed, in contrast, can write checks on an account with a zero balance (i.e., on"thin air") -- and those checks will be honored.

It seems to me that public awareness of the Fed's activities is pretty much limited to the Fed Funds rate and the discount rate. In other words, it seems likely that well read people generally understand that the Fed controls short term interest rates. I tend to believe that the Fed's Open Market Operations are less well understood. The Fed can increase or decrease the money supply at will. When the Fed purchases US T Bonds or T Notes in the open market (through bond dealers), it writes checks to cover those purchases. That flows cash into the economy and increases the money supply.

In contrast, when the Fed sells T Bonds or Notes in the open market, it receives money in return for those securities. That decreases the money supply by withdrawing funds from the economy. It seems clear that virtually all regular visitors to this website understand that we have a fiat money system (the dollar has value simply because the U.S. government says it does; there is no intrinsic value to our currency because it is not backed by something substantial like gold).

As long as the Fed manages the money supply so that it grows roughly at the same pace as the economy, all should be well (in theory, at least). But if the money supply grows a great deal more rapidly than the economy, trouble lies ahead. This is the situation in which we find ourselves today. As I said, when you or I write a hot check, there are consequences, but they are specific to you or me. When the Fed writes a hot check, we all share in the consequences. The Fed is writing lots of "hot" checks these days. The Fed's balance sheet is being loaded up with lots of what appear to be junk financial assets.

Speaking for myself, I am frightened by what I see happening all around us. All great empires eventually collapse and the Great American Experiment will meet its demise at some point. I had rather hoped that we could jolly things along for another decade or so, allowing time for me to be tucked nicely into my Permanent Archive, before TSHTF. Perhaps that will still happen and perhaps not. I am grateful that we cannot know the future with any certainty. Let us keep our sense of humor and let us be fascinated observers of the historic events that are happening today.

There is an ancient Chinese proverb, which some would characterize as a curse. It goes like this: "May you live in interesting times". In this context, "interesting times" might be you and your family subsistence farming on the Asian steppes... and Ghenghis Khan happens by with his Mongol hordes.

caroline_culbert's picture
caroline_culbert
Status: Platinum Member (Offline)
Joined: Oct 2 2008
Posts: 624
Re: Open Market Transactions
BSV wrote:

All great empires eventually collapse and the Great American Experiment will meet its demise at some point.

You are so right... it's just a matter of "when", not, "if".

BSV wrote:

In this context, "interesting times" might be you and your family subsistence farming on the Asian steppes... and Ghenghis Khan happens by with his Mongol hordes.

Very true....

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