November 20, 2023

The Fed's generation of profit, interest, and capital gains is second to none

Comment on Brian Romanchuk on 'No, QE Is Not Costless'

The US economy runs on profit. The 3-sector  ProfitLaw Q≡(G−T)+(I−S)+Yd implies that the greater part is produced by deficit-spending/money-creation. The institutional setup ― including Congress/Fed/Treasury/Wall Street/Big Business ― guarantees the  Oligarchy's continuous self-alimentation with  Profit. Profit generation has worked just fine over the last 200+ years.

So, private financial wealth grows with public debt and in the form of bonds becomes the eternal interest cash cow for the  Oligarchy. WeThePeople owe the public debt and are taxed for interest. The IRS ensures that interest is paid on time to the Oligarchy.

The profit/interest double-whopper explains the observable time path of distribution i.e. the exponentially growing inequality of income/wealth in the so-called free market economies.

In sum, the Fed is pivotal for the creation of the profit/interest/financial wealth of the US economy respectively its oligarchic owners. Actually, that's the Fed's main task. 

How does this work over the interest rate cycle? Remember how Mr. Volker pushed the interest rate up to exorbitant heights and how it then fell gradually to the zero lower bound?

Everybody knows that there is an inverse relation between the interest rate and the current value of a bond. So, bondholders (banks, funds, asset management groups, investment management groups, etc.) could realize capital gains all the way down from the Volker peak until the interest reached the zero lower bound.

At this point, the easy part of the game was over. The Fed could not lower the interest rates any further and everybody knew that nominal/realized capital losses would be inevitable as soon as the  Fed would raise interest rates again. But the Fed wouldn't commit such financial cruelties to the esteemed holders of public debt? So, somehow the Fed was trapped at the zero lower bound.

At this point ― lowest interest rate and highest bond value ― the Fed started QE i.e. buying bonds from its financial market “customers/partners/colleagues” who swapped their bonds for liquidity a.k.a central bank balances.

Smart move, because in this way the big Wall Street players avoided any nominal/realized losses when the interest rate increases eventually happened. As they did when the Fed declared to fight inflation at any cost. Those who were hit immediately with nominal losses were some banks and institutional investors who traditionally hold bonds to maturity ― and, of course, the Fed itself with its gargantuan QE assets.

Over the interest rate cycle, the losses of the  Fed during the current phase of rising interest rates are the counterpart of the realized capital gains of fixed-interest securities during the phase of falling interest rates. In other words, with QE the Fed acted as a direct Profit Pump for the Oligarchy.

Seen from the Oligarchy, the Fed's generation of profit, interest, and capital gains is second to none.

Egmont Kakarot-Handtke