by Keith Weiner
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Most people have a basic idea that inflation is when prices rise, and that this is caused by an increase in the money supply. Since the Federal Reserve is rapidly increasing the money supply, it is only common sense to expect this will hurt us sooner or later. It is absolutely wreaking havoc, though not how you might assume. A simplified idea of inflation is good enough for casual conversation. However, to see what quantitative easing is doing to us requires a more precise understanding.
Inflation is, at root, a monetary fraud.
It helps to understand the dollar, before building the fraud case. The dollar is a debt. Did you ever wonder why we call it a dollar bill? Bill is an old word for a certificate showing that money is owed. On the paper dollar, they don’t print “bill” but “Federal Reserve Note.” Note is another word for money owed. The dollar is a debt owed by the Fed.
The Fed is a bank, and like any bank it must have an asset to match every liability. So long as it owns a dollar’s worth of good assets for every dollar it owes, then the Fed is solvent. However, if its assets fall below its debts, then the market will not accept its currency.
The lion’s share of the Fed’s assets is the US government’s debt—Treasury bonds. Yes that’s right, the government’s debt is its central bank’s asset. If you are picturing Uncle Sam’s purse owing money to his billfold, that is about it. Incredibly, the billfold counts the purse’s promises to pay as an asset.
The system holds together so long as Uncle Sam is servicing his debt. This is not in jeopardy in the near future, but debt default is inevitable. The sad reality is that the government has no means to repay it. The issue is not simply the sheer size, though 17 trillion is certainly an alarming number. Nor is it just the lack of discipline of our political class, though they certainly love to spend. The debt itself is inherently bad.
In my last column, I said that lending and borrowing literally built our civilization. Let’s first look at this kind of borrowing and then at how government debt differs.
Many startups borrow money to start or grow their businesses. In 1977 Steve Jobs used a $170,000 loan to launch Apple Computer. This money was well invested, and helped build an enduring powerhouse. Apple made its founders and their investors very rich, and improved the lives of billions of people globally.
A loan transfers capital from lender to borrower. This enables the borrower to immediately consume resources that it does not own—the lender’s resources. In exchange, the borrower promises to return these resources in the future and a bit more as interest.
It works so long as the borrower uses the capital to produce something new. New production generates new profits. These profits are enough to pay back what was borrowed plus interest, and enough for the borrower to make money too.
If the borrower does not increase production, then it must default sooner or later. This is because it has no means—no profits—from which to make payments. This can happen through honest error, when an entrepreneur miscalculates the market opportunity for his new product. Unfortunately, there are also criminals who do it on purpose. Bernie Madoff wasted investors’ money on his lavish lifestyle, producing nothing. Criminal schemes like that always collapse.
This unfortunately describes the US government. Some of its borrowing does finance new production, but the bulk is consumed. Like Madoff, the government has no way to repay, though it can keep its scheme going far longer. It can borrow fresh money to pay off old debt as it matures, but the scheme must inevitably collapse.
Borrowing without the intent to repay is not really borrowing at all. It’s fraud.
Counterfeit $100 Bill (Photo credit: Travis Goodspeed)
The Fed buys the government’s fraudulent bonds, issuing dollars to finance these purchases. The Fed deceives us into accepting this bad paper as currency by making its new dollars look like real currency. This is the very essence of counterfeiting.
Inflation is the official counterfeiting of the currency. The consequences will be the total collapse of the people’s trust, along with the government’s bad bond and the Fed’s bad dollar.
3 comments
wesfree
2016-04-14 at 04:06 (UTC 2) Link to this comment
On Inflation = Counterfeiting… I agree wholeheartedly with your construction of inflation as the issuance of counterfeit credit. And there can be no doubt that the FED is responsible for some of the thin-air, counterfeit credit creation in its “asset” purchases, injecting these thin-air “money” zombies into the banking system. However, the FEDs balance sheet is not the whole story, in my view – not even the biggest part. I always get the sense that you tend to leave to one side (or ignore entirely) the nearly identical, but more insidious fraudulent, counterfeit credit creation process engaged in on a much-grander scale by the US commercial banking sector. I recently read a treatment by you concerning the so-called “fractional reserve banking system” and your well-formed concerns with duration mismatch, but I also seem to recall the inherent horror (and rejection of??) in your description of a bank’s ability to create assets out of thin air… saying something like this would be “impossible” or something akin to this. Are you denying that banks do this, or merely trying to draw attention to the absurdity of the fact? I’m not sure if you were being sarcastic, or not. Yikes: even Krugman still seems to be lurking in the mists of some sort of loanable funds model, that posits (just like most persons on the street) the banks are lending out their deposits. This has got the true story quite inverted I believe.
However, a slew of documents (some originating in the Federal Reserve research papers dating back to the 1960s – and some, including recent “revelations” by the Bank of England) have made it quite clear (if it wasn’t all along), that the commercial banking system is responsible for the vast majority of ex-nihilo, counterfeit credit creation through the act of creating loans. No loans, no money. (Forget interest!) Loans create “deposits” liabilities out of thin-air, and ALSO merely create the loan assets in the same way – by making the offsetting digital entry in the ledgers. What makes this side of the counterfeit credit creation so insidious, is the fungibility of bank credit, at par, with Federal Reserve Notes. Lately, of course, the commercial banks are making it more and more difficult to redeem their bank credits into “cash” -Federal Reserve Notes (by imposing cash withdrawal limits; advance notification requirements; Know-your-customer and money-laundering rules add further complications. ATMs have fairly strict withdrawal limits that vary by customer even). Banks create this fraudulent credit “money” in this way, out of thin air by loaning it into existence – and generally look for the necessary reserves during the next accounting period. (Obviously, in these days of vast excess reserves, this is even less of a factor…) The loaning bit PRECEDES the deposit bit. In theory, a properly chartered bank (because possessed of shareholder capital) could create quite a lot of “money” without any “deposits” whatsoever.
But casting these new spotlights on an unlawful credit-creation mechanism used (under the law?) by the commercial banking system does not excuse the fact that this has been well known in banking circles since the creation of checkable, on demand “deposits” in the 19th century. The process is NO different than “Wildcat” note issuance during the ante-bellum, badly named “free-banking” era in America. The difference is – and it’s a big difference – is that a cheque could be used. Today, it’s even worse – as there is no “token” (note, cheque etc.) used whatsoever. The cashier is barely cognizant of whether the payer is using credit or direct debit. And so, total credit market debt obligations amount to nearly 70 trillion dollars. The FEDs balance sheet is only a wee-bit of that, and total government debt (admitted to) is around 19 Trillion$. So, pray tell, why do you NOT include the commercial banking sector as the greater culprit in the immoral creation of inflation, as defined?
ps: I draw a distinction between that which is lawful (right, correct, moral, just), and that which is protected under unjust laws – or worse, as may be the case with our current banking system, the absence of laws… Like the now archaic, definitions of the dollar (first in terms of silver, then later of gold) which actually no longer exist – and despite searching – I cannot actually find any statutory basis authorizing this fraudulent form of credit creation. Any who are aware of such, please do point me to a link… SVP
Keith Weiner
2016-04-14 at 12:46 (UTC 2) Link to this comment
Hello Wesfree,
Thanks for your thoughtful comment.
The banks do not create something out of nothing. They borrow. Please see my recent article: https://snbchf.com/gold-standard/money-printing/
And I just posted this today: https://snbchf.com/gold-standard/who-lends-to-the-fed/
wesfree
2016-04-14 at 20:16 (UTC 2) Link to this comment
Dear Keith – Thanks for your kind and prompt reply.
I’m going to try and get to the bottom of this, and I’ve chosen your forum and your expertise in which to renew my attempt. When this issue spilled out onto the pages of the New York Times and our charming Nobel Prize-winning, neo-Keynesian figurehead, Paul Krugman elected to provide his wisdom – it ended very badly – without providing an answer! Most of his readers (as evident in the comments) not only called him out for his evasiveness, but also for his rudeness. You and Mish Shedlock got into this in your discussion over duration mismatch a while back and it was NOT SETTLED either. I am the farthest thing from an MMTer (and I think Steve Keen is too – he just hasn’t realized it yet), but their balance-sheet-centric view of the world (which though flawed) does have its advantages in this particular issue… That the entire population of economists in the world cannot agree on the actual mechanics of money creation (and its accounting) once and for all speaks to either the existence of one gigantic Ponzi, the existence of the Matrix, or the complete and utter “capture” of the economics profession by the banking cartel. I’ve recognized in your writings that you’re not afraid to break some eggs in expositions of how things actually work. But in this particular case, your statements lack specificity and clarity. You have an opportunity here – and I, together with countless others, should benefit from having this issue definitively settled. It remains open – and it is by far the biggest elephant in the global china shoppe… Please help.
So here I go with the predicate.:
Stipulations: Only the Treasury actually prints Federal Reserve Bank notes, on the orders of the Fed. The US Treasury will print as many as are demanded, without limit. But this is not a “populist” appeal. This is an appeal for knowledge and certainty. So NO – I am NOT referring to “money” printing per se – rather the “ex-nihilo” (out of thin-air) digital creation of fiduciary media (that stuff which is capable of being exchanged for labor, goods and services) by the Fed, as well as the Commercial Banking Sector (we’ll leave the non-bank, shadow banking sector for another day…). So it is CREDIT money creation that I am referring to here – as you’ve not really defined what you mean by money (other than your JPM “gold is money” quote);
We totally agree on the 2-4% of the “money” supply that is in physical, token (paper currency and coin). The physical paper Federal Reserve Notes (currency) are their liabilities, and the coins are actually the only direct liabilities of the Treasury.
Let’s talk about the 96-98% of the rest of the credit “money” aggregates – but let’s try to avoid splitting hairs (and they are thick hairs) between the various Ms and their measurement. Let’s agree to limit our discussion to the mechanics of the creation of demand deposit liabilities in the commercial banking sector arising from (or associated with?) commercial bank loans.
You say (and Krugman first denies, then waffles), that commercial banks are “borrowing” the “money” they lend. I assume you mean that they are on-lending the monies that are deposited (or in legal terms, loaned) in the banks by the banks clientele (from whatever source) – but your meaning is uncharacteristically unclear on this point. This conception is diametrically opposed to the description of the mechanics of bank lending propounded by those who are actually doing it:
Friedman, David H., “I Bet You Thought”, Federal Reserve Bank of New York. N.Y., 1977, 36p. (“Commercial Banks create checkbook money whenever they grant a loan, simply by adding new deposit dollars to accounts on their books in exchange for a borrower’s IOU.”
“Modern Money Mechanics – A Workbook on Bank Reserves and Deposit Expansion” published by the Federal Reserve Bank of Chicago, originally written in 1961 (This document also describes in detail the ex-nihilo credit creation of the FED when it makes “asset purchases”, i.e., QE);
“Money in the Modern Economy: An Introduction” – Bank of England Quarterly Bulletin Q1 2014 (plus an “official” video too : https://www.youtube.com/watch?v=CvRAqR2pAgw)
“What is Money and How is it Created” (Forbes: http://www.forbes.com/sites/stevekeen/2015/02/28/what-is-money-and-how-is-it-created/#28c5f2de56a3)
“That Couldn’t Possibly Be True”, Paul Rosenberg – 27February 2015
Paul Rosenberghttp://www.caseyresearch.com/articles/that-couldnt-possibly-be-true-the-startling-truth-about-the-us-dollar
“Monetary Reform: A Better Monetary System For Iceland” : March 2015. Here’s a quote from page 35:
“Speaking on a panel in a conference in Toronto in April 2014, Lord Adair Turner, head of the Financial Services Authority 2008-2013, describes the money multiplier model as “mythological” and explains how banks create new money when they make loans: “If you pick up most undergraduate textbooks…and you see how they describe the role of the banking system, they make two mistakes. First of all they describe a system which takes money from savers, and lends it to borrowers, failing to realise that the banking system creates credit, money and purchasing power ab inicio, de novo, and with an important role therefore within the economy. But also, again and again, [the textbooks] say “Well what banks do is they take deposits from households and they lend money to businesses, making the capital allocation process between alternative capital investments.” As a description of what modern advanced economy banking systems do, this is completely mythological.”
Another quote (page 36 of the Iceland Monetary Reform document):
“In conclusion, the credit creation model sees causality in the banking system occurring in the following way:
When banks lend they create new deposits and thereby new money. Lending may increase a bank’s demand for reserves in order to settle payments to other banks. The central bank must provide reserves when a bank needs them. While money is created when banks lend money, money is deleted when bank loans are repaid.”
And here is the best summary (with links) of the incredible public debate between Steve Keen and Paul Krugman concerning this issue: https://unlearningeconomics.wordpress.com/2012/04/03/the-keenkrugman-debate-a-summary/
Scott Fullwiler schools Krugman with SPECIFICS OF THE BALANCE SHEET on the way: http://www.nakedcapitalism.com/2012/04/scott-fullwiler-krugmans-flashing-neon-sign.html
— Okay: I’ve tried to assemble the basis for my confusion from as many and varied sources as would be most representative of the major positions. So what say ye? To me, the very institutions ostensibly in charge of the monetary function (and its regulation) are prettly clearly stating that the commercial banks are not, (as you say) “borrowing” the money. Rather, according to them – the banks are “creating” the money ex-nihilo. They use that word: create. Not borrow.
Henry the Homeowner’s mortgage is funded from thin air with an accounting entry only.
Your referenced links, though interesting, do not address these mechanics in any way. How can it be that we have on the one hand the now-controlling church of economics in the world operating on the basis of models that essentially ignore the existence of (and creation of) money and credit – and on the other hand, economists who have a better understanding of the actual mechanics of ex-nihilo money creation (and, bizarrely, seem to accept this as Okay??); and then in another corner of the ring, those such as yourself (and the vast majority of the public who still have the Jimmy Stewart scene in their minds), who appear to be in denial of the actual, chronology involved in “money” creation.
Why, Keith, when the Central Banks themselves are telling you that banks are NEITHER loaning out reserves, NOR are they loaning out deposits “borrowed” from depositors, do you seem to deny this? I don’t get it.
This is where the “populists” may be justified inserting a bunch of well-worn banking quotes… Friedman’s characterization of economics IS apt. Henry Ford’s “revolution in the streets tomorrow” revulsion is also on point. Frederick Soddy, (unfairly written-off by the banking cartel then and now as a “crank”) – said it best by essentially proposing a simple calculator as the solution. Please help me to arrive a definitive answer, that I might spread the word far and wide… Thank you.