Feb 02

Related information:

MSNBC Exposes President Obama’s lies: FED GAVE Banks Access to 23.7 TRILLION DOLLARS NOT $700 Billion!


the-fed-as-giant-counterfeiter

San Jose State economics professor Jeffrey Rogers Hummel tells all his students that the easiest way to understand the Federal Reserve is to think of it as a giant, legalized counterfeiter. I had always known that the Fed and other central banks were like counterfeiters, but I still thought that the actual mechanics of open-market operations and so forth actually provided some important distinctions.

In large part because of my frequent email exchanges with Hummel, I now realize that I was being naïve. Once you understand the details of modern central banking, you are able to step back and see that it truly is a way for the government to use the printing press to pay its bills. All of the complicated process of targeting interest rates through buying Treasuries simply hides this essential point – and perhaps deliberately so.

An Old-Fashioned Monarch With a Printing Press

Before we examine Fed operations, let’s start with something simpler. Suppose there is a powerful monarch reigning over a large, industrialized country. The monarch has managed to wean his subjects off commodity money such as gold or silver, and instead they use fiat notes, rectangular slips of paper featuring the king’s portrait. The king has a printing press at his disposal, which gives him unlimited ability to create more slips of paper with which he can buy goods throughout his kingdom.

At first, one might think that our hypothetical king has infinite wealth. But upon reflection, we see that there are actually pragmatic limits on how much new money he will print up each year. It’s true that there are no legal constraints on how many notes he can create, but the more monetary inflation he sows, the greater the price inflation he will reap.

At some point, the monarch would actually make himself poorer in the long run by running the printing press too heavily in the present. For example, if he doubled the stock of money in one year, the resulting price inflation would destabilize his economy and cause much needless capital consumption. His subjects would be less willing to invest in their businesses and retirement portfolios, knowing that he might effectively confiscate their savings again through massive creation of new money. Foreign investors too would be wary of exposing themselves to his country if he made his fiat currency too volatile.

Because of these considerations, the monarch would no doubt run off new money every year from his printing press, but he wouldn’t overdo it. He would aim for a moderate level of constant price inflation, with the purchasing power of his fiat currency slowly falling over time in a predictable manner. Each year, the new influx of money into the economy would represent a transfer of wealth from all other currency holders into the king’s possession.

Now what if our monarch is really profligate? What if he wants to spend more money than the income and tribute he earns in his position as monarch, even including the amount of new money he dares to create each year with his printing press, can support? In this case, the monarch can still resort to old-fashioned borrowing. Therefore in any given year, the monarch can only spend what he collects in tribute (taxes), debt financing, and inflation.

Modern Counterfeiting, Fed Style

At first glance, our present monetary system is nothing like the simple tale of a king with a printing press. For one thing, the US Treasury is a distinct entity from the Federal Reserve. When the US federal government runs a budget deficit, it can’t simply have the Fed print up enough $100 bills to cover the shortfall. No, the Treasury always covers its budget deficits by issuing debt, referred to as Treasuries. These are bonds, IOUs sold by the Treasury to outside investors who lend the Treasury money today in the hopes of being paid back in the future.

But wait, there’s more to the story. One of the main buyers of this Treasury debt is the Federal Reserve itself. This phenomenon is especially pronounced during emergencies such as major wars and the current financial crisis. Indeed, in the second quarter of 2009, the Federal Reserve was the effective buyer of some 48 percent of the new Treasury debt issued that period, as part of its “quantitative easing.” It’s true, the Fed doesn’t show up at the Treasury auctions and directly buy the new T-bills and so forth, but private dealers pay higher prices for the Treasuries knowing that the Fed is waiting in the wings to pick them up.

At this point let’s review exactly what happens when the Federal Reserve buys Treasuries from private dealers. Let’s say the Fed wants to buy $1 million worth of T-bills from Joe Smith. So it writes Joe a check for $1 million, drawn on the Fed itself. Joe hands the T-bills over to the Fed, where they end up on the asset side of its balance sheet. Joe then deposits the check in his personal checking account, which goes up by $1 million.

So at this point the Fed has increased the money supply by $1 million. In normal times, because of the fractional-reserve banking system, Joe’s bank would lend out $900,000 of the new deposit to another customer, so that the money supply would grow even further. But that’s not what interests us in this article, so we’ll leave that train of thought.

What we want to focus on is the effect of the Fed’s purchase on the US Treasury. By entering the bond market and buying Treasuries (with money created out of thin air), the Fed pushes up the price of the bonds. That of course means that their yield drops. So, for example, if the Treasury issues a T-bill promising to pay the holder $10,000 in 12 months, then the auction price determines how much money the Treasury actually gets to borrow now in exchange for this promise to pay back $10,000 in one year. If the demand is such that people pay $9,901 for each T-bill with a face value of $10,000, then the Treasury gets to borrow money for a year at an interest rate of 1 percent.

Already we see why the folks at the Treasury are big fans of the Fed’s “quantitative easing” program, in which Bernanke decided it was in the national interest to begin adding more than a trillion dollars’ worth of Treasury debt to the Fed’s balance sheet. If nothing else, the Fed’s massive buying of Treasury debt pushes up the auction price of the Treasuries, meaning the federal government can borrow at cheaper interest rates.

Now, if this were the whole story, it would be fishy but not nearly as bad as our hypothetical monarch with the printing press. Sure, the Fed would create new dollars (which would push up dollar prices of goods and services) in order to keep the Treasury’s borrowing costs low. But still, the Treasury would have to pay some interest on its debt, especially for longer-dated debt with higher yields, like 10-year Treasury notes. So although the mechanism we have described would encourage the Treasury to run higher deficits at the expense of average people, who suffer from rising prices, things don’t seem nearly as crooked as they were in the case of our monarch.

Ah, but we’re not done yet. Not only does the Fed’s accumulation of Treasury debt artificially push down the interest rate, but the Fed gives the interest payments right back to the Treasury! After all, interest is how the Fed “makes money.” It writes checks on itself (created out of thin air) and accumulates assets, and then earns the interest and (in some cases) capital gains on the assets. But after the Fed pays its employees, pays its electric bill, and throws the staff Christmas party, it remits the excess earnings back to the Treasury.

For example, in fiscal year 2008 the Federal Reserve distributed to the US Treasury some $31.7 billion (page 173)Download PDF of its net earnings. To repeat, much of this money consisted of interest payments that the Treasury paid out to the holders of its debt, who just so happened to be the Fed for much of it. So not only is the official rate of interest kept artificially low by the Fed’s money-creation, but the interest payments themselves are largely refunded to the Treasury, to the extent that the Fed ends up holding the Treasuries rather than outsiders.

All right, so the Fed (a) suppresses the interest rate on Treasury debt and (b) refunds virtually all of the interest payments on Treasury debt held by the Fed. And remember, the way the Fed does this is through creating new dollars out of thin air, in order to buy the Treasury debt from the original investors who lent money to the Treasury. Therefore the Fed is clearly giving aid to the US government’s deficit spending at the expense of everyone holding assets denominated in US dollars.

Still, the one thing holding back the complete recklessness of the feds is that they still have to pay off the principal of their bonds when they mature, right? In other words, all we’ve really shown is that the Fed allows the Treasury to run deficits virtually at zero interest expense, at least for debt held by the Fed. But this is still a far cry from our hypothetical monarch, who had a whole component of his expenses which he met year in and year out by running the printing press.

Sorry, but our own monetary system has the same feature. When the Treasury securities held by the Fed mature – so that the Treasury has to pay back the face value in principal – the Fed rolls over the debt. Over time, the nominal market value of the Fed’s holdings of Treasury debt continually grows. Barring a sudden reversal in this policy, the Treasury knows that it will never have to pay off this debt. For all practical purposes, any Treasury debt ultimately finding its way onto the Fed’s balance sheet is economically equivalent to our monarch running the printing press to pay his bills.[1]

We have just one last consideration. Up till now we’ve seen that the modern US government, with its complicated central bank and fiat money system, operates essentially as a king with a simple printing press, to the extent that the Fed is willing to accumulate larger holdings of Treasury debt. But what determines how much the Fed is willing to take on? At what point would the Fed decide to ease off on its open-market operations and stop creating so many new dollars to (indirectly) hand over to the government?

The ultimate constraint on the Fed’s operations is the same one our hypothetical king faced: investor and citizen backlash in response to rising prices. That is, the Federal Reserve can only absorb so much of the Treasury’s new debt each year because too much dollar-creation would lead to unacceptably high price inflation. Thus our profligate government, like the hypothetical monarch, must finance some of its spending through traditional borrowing from private citizens and other governments.

Conclusion

Stripped of its fancy terminology and confusing mechanics, modern central banking boils down to a legalized counterfeiting operation. If there were suddenly a widespread public outcry to “punt the press,” we can bet our hypothetical monarch would mobilize all his allies in the media to discredit the people threatening his source of revenue. In that light, we can understand the reaction today to people calling to “end the Fed.”

Monday, February 01, 2010
by Robert P. Murphy

Source: Mises

The Fed and the US government are destroying America:

White House to Paint Grim Fiscal Picture: Another Record Budget Deficit

US: GDP Mirage – The Last Hurrah

Controller: Pennsylvania Capital Should Weigh Bankruptcy

Marc Faber: Obama Makes Bush Look Like a Genius

Obamanomics: Why Did the ‘Stimulus’ Fail to Help the US Economy?

Paul Craig Roberts: How Wall Street Destroyed Health Care – Greed, Be Thou My God

Ron Paul: US Foreign Policy is Bankrupting America

Rep. Ron Paul: State of the Republic Address – ‘Dangerous Times Indeed.’

America’s Impending Master Class Dictatorship! (MUST-READ!)

The CFR Controls American News/Media

Senate Proposes Increasing US Debt Limit to $14.3 Trillion: “If Congress does not enact this legislation, and soon, then the Treasury would default on its debt for the first time in history,” said Senate Finance Committee Chairman Max Baucus

US: Unfunded Benefits Dig States’ $3 Trillion Hole

Illinois enters a state of insolvency: ‘We’re close to de facto bankruptcy, if not de jure bankruptcy.’

The No.1 Trend Forecaster Gerald Celente: Financial Mafia Controlling US and Wall Street

Peter Schiff: The Lunacy of US Government Programs

– Former Dean of Harvard College Harry R. Lewis: Larry Summers, Robert Rubin: Will The Harvard Shadow Elite Bankrupt The University And The Country?

Experts: Dollar Crisis Looms if US Doesn’t Curb Debt

Marc Faber on Coming Sovereign Debt Crisis: Next Countries to Default are the US, Japan and the ‘PIIGS’

Fitch: US Must Cut Spending To Save AAA Rating; US December Deficit Nearly Doubles

The Coming Sovereign Debt Crisis

US slides deeper into depression as Wall Street revels

PIMCO’S Bill Gross: ‘Let’s Get Fisical’ (… or why the US will not make it.)

Barack Obama’s Health Care Lies And Reversals

US sheds 85,000 jobs in December; Record 40% Of Unemployed Without Job For 27+ Weeks

Peter Schiff on Fast Money: ‘America is broke’; ‘The Fed created a currency crisis’; ‘Dollar to collapse 50-70% or more’

US: Public Pensions Face $2 Trillion Deficit

U.S. Avoids Technical Default By Three Days

As an American, I refuse to buy mandatory health insurance … that supports Big Pharma

The US Government Is Preparing For Collapse: Your Legal Right To Redeem Your Money Market Account Has Been Denied

Prof. Dr. David Michael Green: Now I’m Really Getting Pissed Off … With Obama

US Treasuries Post Worst Performance Among Sovereign Markets In 2009

US losses will top $400 billion on Fannie Mae and Freddie Mac

US: More Ammo For The Treasury Bazooka

US government wants farmers to use coal waste on fields

The No.1 Trend Forecaster Gerald Celente: The Terror And The Crash of 2010

We’re Screwed! Hyperinflation like in the Weimar Republic; Great Depression worse than in the 1930s

US Congress: Banksters Get $4 Trillion Gift From Barney Frank

Treason: Obama gives INTERPOL immunity from the Constitution (Amending Executive Order 12425)

Peter Schiff on Obamacare, Freddie Mac & Fannie Mae: The Nightmare Before Christmas

Obama administration backs Fannie Mae and Freddie Mac no matter how big their losses may be

Rep. Dennis Kucinich: US War Presidents ignore Congress and Constitution

Obamacare: Big payoffs to senators on health bill stoke public anger

US: Trillions Of Troubles Ahead

Chinese central banker Zhu Min: ‘The world does not have so much money to buy more US Treasuries.’

Obamacare: Change Nobody Believes In

Obama’s surge comes at a cost: At least $57,077.60 per minute

US National Debt Tops Debt Limit

Hypocrite in Chief (Funny):
President Obama: Another Busy Day in The Oval Office!

Fascism in America: By Political Definition The US Is Now Fascist, Not A Constitutional Republic

John Williams of Shadowstats: Prepare For The Hyperinflationary Great Depression

Liar in Chief (NOT funny!!!):
Barack Obama Lies 7 Times In Under 2 Minutes!!!!!

Robert Fisk, The Independent’s award-winning Middle East correspondent: Obama is a Disaster, Worse than Bush

Rep. Dennis Kucinich: ‘These Wars Are Corrupting The Heart Of Our Nation!’

Famous Investor Jim Rogers: Incompetence In Washington, Abolish The Fed And The Treasury

Rep. Dennis Kucinich: The Truth About Afghanistan

Obama’s Big Sellout (Rolling Stone Magazine)

Obama administration to lift debt ceiling by $1.8 trillion

Climategate: President Obama’s rule by EPA decree is a coup d’etat against Congress, made in Britain

Obama administration tells Pakistan: Tackle Taliban or we will

MSNBC Rachel Maddow: War President Obama

Ron Paul: ‘Obama is Actually Preparing Us For Perpetual War’

–  Afghanistan Surge to Cost At Least $40 Billion, That Is $1.333.333 For One US Soldier Per Year

Rep. Brad Sherman: Geithner rejects $1 trillion limit on bailout power (Section 1204 is unlimited in dollar amount!)

Liar in Chief (Over 300 soldiers died in 2009 because of this lie!!!):
Obama: ‘I will promise you this, that if we have not gotten our troops out by the time I am President, it is the first thing I will do. I will get our troops home. We will bring an end to this war. You can take that to the bank.’

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