Fed buys 7 billion in Treasury bonds -- what does this mean?

[Craig]

Are there any economics or finance majors on this board?  How does the federal reserve bank have 7 billion to buy these treasury bonds?  Who issued the treasury bonds--the U.S. government?  Who will pay the interest?  To whom is the interest paid?  Will the 7 billion be paid back in full with interest? 

Let's say Japan bought the bonds from the U.S. government.  That means Japan holds the bonds for 10 years and interest is paid at say 3.29%/year from the U.S. government to the Japanese.  At the end of 10 years would the U.S. government have to also pay back the 7 billion that the Japanese paid for the bonds? 

[Guest nybullsfan]

Whenever the Fed wants to INCREASE the money supply, they BUY Treasuries, and when they want to DECREASE the money supply, they SELL Treasuries.

The Fed is forbidden by law from buying any securities directly from the US Treasury. In effect, they're limited to buying "used" (pre-owned) securities from whoever bought them from the US Treasury.

The Fed doesn't HAVE the money to buy them, it CREATES the money to buy them.

For example, the Fed issues an offer to buy, and ABC Bank decides to sell $10,000,000 of their inventory. ABC delivers the securities to the Fed, and the Fed increases ABC's reserve account by $10m. It's just an accounting entry. But now, ABC can go loan out that $10m and use it just like any other funds it has available to itself.

Then, when any Treasury matures, the US redeems it (buys it back) for the $1,000 face value.

And on Treasuries that mature in more than 1 year, the US also makes semi-annual interest (coupon) payments.

More info here:

http://en.wikipedia.org/wiki/Treasury_security

http://en.wikipedia.org/wiki/Money_supply#United_States

[Craig]

"ABC delivers the securities to the Fed, and the Fed increases ABC's reserve account by $10m."

This is creating money out of thin air.  The fed didn't have the 10 milliion to begin with.  That's why they borrowed it from ABC bank in the first place.  I don't get it. 

[Guest nybullsfan]

"ABC delivers the securities to the Fed, and the Fed increases ABC's reserve account by $10m."

This is creating money out of thin air.  The fed didn't have the 10 milliion to begin with.  That's why they borrowed it from ABC bank in the first place.  I don't get it. 

It is absolutely creating money out of thin air. That's exactly what the Fed was created to do.

The Fed doesn't borrow money, they create it.

The Treasury borrows money.

Two completely different organizations.

BTW, as well as creating it, the Fed also destroys money. When they want to reduce the money supply they sell their holdings of Treasury Securities. For example, the Fed offers $10m in securities, and ABC bids to buy them. Then the Fed delivers the securities to ABC, and debits their account. ABC used to have $10m, now they don't. But they do have the securities.

You create money too.

Every time you make a deposit to the bank,you are creating money. If you deposit $100, the bank's going to loan out about $90 of it. That $90 will (eventually) get deposited in some other bank. That bank will loan out about $80 of it. And so on. This is called the money multiplier.

Similarly, whenever you remove (withdraw) money from the bank, you are destroying money. The supply of money is very dynamic, which is why it can be difficult to manage.