QE2, Monetizing Debt, Currency Wars, and the Fed, how much do the spinsters really even understand? It is a very complicated topic that professionals even fail to comprehend. The questions that need to be addressed are what is money? How does the money supply expand and who is the Fed anyway? Is it even possible for them to “Monetize”? What about China, how long can they artificially hold a rate without devaluing their own currency?
Money is not what most people think it is. Originally paper money was a note redeemable for Gold. These days it is all fiat money which is not backed by anything other than the government’s “good faith”. So what is a dollar? Is it debt? Just look at any dollar bill in your pocket and you will see that is says “Federal Reserve Note”. A Note is debt, which is where most people have lost the connection. The US$ is debt, and this debt is what most people think of as money. It is legal tender and therefore money, but most don’t realize that it is actually debt. Even if you somehow have one of the old “United States Note” bills, it is still a note. Yes, there are two notes to complicate it further, and there is a difference. However, Federal Reserve Notes are the only ones that are still produced today. According to Wikipedia the difference is as follows:
“Both United States Notes and Federal Reserve Notes are parts of the national currency of the United States, and both have been legal tender since the gold recall of 1933. Both have been used in circulation as money in the same way. However, the issuing authority for them came from different statutes. United States Notes were created as fiat currency, in that the government has never categorically guaranteed to redeem them for precious metal - even though at times, such as after the specie resumption of 1879, federal officials were authorized to do so if requested. The difference between a United States Note and a Federal Reserve Note is that a United States Note represented a "bill of credit" and was inserted by the Treasury directly into circulation free of interest. Federal Reserve Notes are backed by debt purchased by the Federal Reserve, and thus generate seigniorage for the Federal Reserve System, which serves as a lending intermediary between the Treasury and the public.”
This leaves us with how the supply of money is created. If money is debt, than money is created when debt is created. If someone goes to the bank for a loan, money supply expands when that loan is issued. The person who borrows the money gets a check from the bank and puts it in their account. The bank lending the money has assets of a loan worth money. They can hold this loan or sell it for money. The bank where the borrower deposits his check from the loan now has fresh deposits on which they can lend more money on. Money has expanded and will expand further depending on how fast banks are lending and money is changing hands.
If money is created with debt, it is also destroyed when debt goes bad or is paid off. Remember all those bad mortgages? That decreases money supply. While most people believe it is the government that controls the supply of money, you can see that money supply can expand or contract in the free market. While government does play a big hand and keeps the statistics of it, they are only a part of the equation.
So can the government just print money like everyone would have you think? Not really. The US Government handed over the printing of money to the Federal Reserve Board (NYSE:FRB) with the Federal Reserve Act of 1913. If the government wants to create money, they have to borrow it. The FRB has money physically printed when it buys newly issued bonds from the US government. The government issues or sells bonds when they borrow money. What the public does not buy, the FRB assumes. This amount that the FRB assumes is newly printed money via a journal entry by the FRB. Like in the free market place, the government is expanding the money supply by borrowing money. Just like everyone else. Maybe that is why they expanded the debt so enormously over the past 10 years, after the internet collapse, to increase the supply of money and keep the economy afloat. In the end it is merely a Keynesian scheme. But all that ever does is to create more false bubbles. You also have to ask if the Government borrowing has kept pace with the pace of defaults. If defaults of debt outpace borrowing the money supply will shrink.
But isn’t the Fed the government? No. The Federal Reserve Board is a privately held corporation owned by banks doing business in the U.S. This information can be found on the Fed’s own website http://www.federalreserve.gov/ , along with the fact that the holders collect a 6% coupon for their ownership of the FRB. To find the actual holders, you will have to file a freedom of information act request. Information from a few years back indicated that the biggest holder is JP Morgan, followed by Wells Fargo.
So could the private Fed monetize the debt? Not unless they forgave the debt they are holding, sold to them by the US Government, or if the US government defaulted on that specific debt. I don’t think the private Fed and the banks that own them and collect the 6% coupon would want that to happen. If the US Government defaulted on any of its debt it would shrink the supply of money and in turn make cash US$’s more scarce. This in turn would make the value of the US$ increase. Reserve currency status comes from the very fact that the US does not print its own money, but instead has the private FRB owned by banks doing business in the country print the money. The US government is just a part of the equation in the supply of that money and is just another debtor to that currency like any private corporation. The US being the largest economy in the world and having the largest military force makes the US$ a world standard. Further, since the majority of the world’s debt is issued in US$’s, there is a demand for those dollars as they are needed to pay back the debts, loans, bonds, ect.
The FRB does not want you to know all of this as you might start hoarding US$’s or not even keep them in the bank. This would drastically slow down the velocity of money, or the rate at which it changes hands. This would decrease the supply of money, and we all know that is the leading factor of the Great Depression, a decrease in money supply. The FRB likes letting people think that the so called “printing” of money decreases the value of the $ as the market is nothing but lemmings. If everyone sees it going in that direction they follow the heard. The FRB has a couple reasons they like people to believe the illusion. If people think the value of the dollar will decrease, they will increase there spending now, to avoid the inflation later. Investors will put there money to work in the market instead of sitting on cash. They hope the stock market’s rise will create a wealth effect and spur consumer demand. The FRB is also fine with the weak dollar scenario as they hope it spurs exports. The problem is the other economies of the world are also in trouble so they don’t want more imports, but rather more exports as well. They realize the game, but need the lemmings themselves, so take the steps to lower their own currencies. If each country keeps forcing their currency lower, it is just a leap frog devaluation that does nothing to stimulate the global demand for goods, and has also led to actual World Wars in the past. You can’t devalue your way to prosperity.
Isn’t that what China is doing? Well, in order for them to keep their currency rate low to the US$, they must act in the market by selling their own currency and buying US$’s. Eventually, they are going to have too much of their own currency in circulation. Most of the US$’s they are buying are invested into US treasury’s, so if the US did default, China would be holding a lot of worthless bonds, like holding any corporation’s worthless bonds. However, their actual cash US dollars would be worth more. Again, a default would cause a decrease in the money supply and a downturn in the economy. This in turn would hit the Chinese economy as well since US consumers would buy less.
The house of cards is layered thick, and nobody wants it to collapse on their watch. The FRB is also smarter than most think, and lets the lemmings fly in directions, while they sit back and laugh. Who really understands how it is really intertwined? Eventually nature must take its course and the money supply will shrink. Eventually the Fed’s game of illusion will be uncovered, the market will drop and the US$ will soar. The question is when?
Disclosure: No Positions