One of the characteristics of a struggling republic is the inability to separate its central bank’s resources from the fiscal largesse of the federal government. Using central bank resources to avoid addressing funding of the government is a sure path to runaway inflation, economic decline, and periodic financial crisis. Take the example of Argentina, whose economy was the same size as that of the US at the turn of the century in 1900. Since then it has experienced repeated bouts of rapid inflation and crises both real and financial. Today its GDP is about the same size as that of North Carolina, which is the US’s 9th largest state in terms of GDP. One of the problems Argentina faced was the ability of the federal government to finance expenditures by relying upon central bank assets. Indeed, “The central bank was a lender of first resort to the treasury,” according to Alfonso Prat-Gay, who ran the central bank from 2002 to 2004.

Early on, the US Federal Reserve was a source of rediscount finance to support the agricultural cycle. During WWII, the Fed subordinated its balance sheet and independence to support the war effort, transferring funds to the Treasury and pegging Treasury rates. That policy culminated in the 1951 Accord, reestablishing the Fed’s position as an independent central bank. In 1996, Congress requested that the GAO study the Fed’s policy of maintaining its surplus account equal to its paid-in capital as of year-end the previous year. The purpose of the surplus accounts to provide a buffer against which losses could be recognized.¹ Member banks are required by the Federal Reserve Act to subscribe to stock in the Federal Reserve Bank in the district in which the member banks are headquartered, and the subscription is to equal to 6% of their paid-in capital and surplus. Hence, the Fed can add to its paid-in capital only as member banks grow and not by issuing more stock.

The GAO study came on the heels of two raids of the Fed’s surplus initiated in the Omnibus Budget Reconciliation Act of 1993. That act, according to the GAO, directed any Reserve Bank whose surplus exceeded 3% of the paid-in capital and surplus of member banks in its district for fiscal years 1997 and 1998, to transfer those surplus funds to the Treasury. And the Reserve Banks making those transfers were not permitted by the Act to replenish their reserves during those two fiscal years.²