De Crash Course 9 & 10
Deze crash course gaat over de veranderingen die de maatschappij te wachten staan. Economische, maar ook maatschappelijke. De focus is uit de aard van de herkomst op de USA, maar ook voor West-Europa bevat het nuttige lessen. Komende weken zullen we er met regelmaat een aantal toepasselijke lessen uit (her)publiceren.
NB: de link naar de gesproken tekst zit onder de link waar de duur staat aangegeven!
Engelstalige transcriptie Chapter 9 – Brief History of US Money
Before we move on to current events, it’s vital that we know how we got here.
I will now present an extremely shortened version of recent US monetary history.
The purpose of this section is to show you that in the past the US government has radically shifted the rules during times of emergency and that our monetary system is really a lot younger than you might think.
After the great financial panic of 1907, when private banker J.P. Morgan stepped in as the lender of last resort, banks began agitating for a government solution.
What was finally decided upon in 1913 was a federally-sponsored cartel, called the Federal Reserve, which sounded governmental but really was not.
The stock of the Federal Reserve was to be held by its privately-owned member banks, not the US government nor the public, which remains the case today.
So what we call the Federal Reserve actually is a federally-sponsored banking cartel, licensed to lend money into existence.
One of the main arguments for creating the Federal Reserve was to have a more central bank able to step in and prevent losses from panics.
How did that work out?
Not very well. Instead of simply being a lender of last resort the Federal Reserve had helped provide the necessary fuel for a speculative bubble in stocks that burst in 1929 with devastating effects.
Among the financial consequences were numerous bank failures a shrinking the money supply by nearly a third in just three years and, in 1933, the US government effectively declared bankruptcy.
At that time, newly-elected President Franklin D. Roosevelt decided to counter the falling money supply in a most drastic manner.
He ordered the confiscation of all privately-held gold and immediately devalued the US dollar.
Up until this time in history, America was on the gold standard, which meant that each paper dollar in circulation was backed by a specific amount of gold, which it could be exchanged for upon demand.
Prior to the seizure it took approximately $21 to buy an ounce of gold and afterwards it took $35.
Soon after, contractual obligations of the U.S. government, such as bonds payable in gold, were nullified, with the approval of the Supreme Court.
This goes to show how governments, in a period of emergency, can change rules and break their own laws even if those laws are written into the Constitution.
All of this seized gold either ended up in the vaults of the Federal Reserve, at the International Monetary Fund or “on the books” of the Federal Reserve.
A grand total of $11 billion dollars was exchanged for all 261 million ounces of the nation’s gold.
In other words, complete control of the gold supply of the most powerful and prosperous nation on earth was exchanged for slightly more than $11 billion dollars literally printed out of thin air.
After just twenty years, a private banking cartel went from an idea to owning all of the wealth of a young, powerful and prosperous nation. Not bad!
Every one of these original 261 million ounces of gold still remain on the books of the Federal Reserve as a private asset, so technically it actually belongs to the shareholders of that corporation, not the American people.
In any event, to end the turmoil of depression and a subsequent world war, and to provide a foundation for global recovery, a conference was held at Bretton Woods, N.H, in 1944, with all the major allied powers attending.
Recognizing that the U.S. then represented nearly half of the global economy, the U.S. dollar was made the global reserve currency.
All other currencies had fixed rates of exchange to the dollar, which in turn was redeemable for gold at 35 dollars per ounce.
The Bretton Woods II system ushered in a period of prosperity and rapid economic recovery. But, there was a flaw in the system.
Nothing in the Bretton Woods agreement prevented the U.S. Federal Reserve from expanding the supply of Federal Reserve Notes as rapidly as it wished.
As this happened, the gold backing behind each dollar steadily declined, such that there was not enough gold to back all of the dollars.
Meanwhile, as the Vietnam War intensified, the U.S. was running budget deficits and flooding the world with paper dollars.
The French, under President Charles DeGaulle, became suspicious that the U.S. would be unable to honor its Bretton Woods obligations to redeem their excess dollars into gold.
As the French exchanged their surplus dollars for gold, the U.S. Treasury’s gold stocks declined alarmingly. Finally, President Nixon declared force majeure on August 15th, 1971, and “slammed the gold window” ending its dollar convertibility.
The last ties of the US dollar to gold were severed. The days of a “gold standard” were over.
That’s what governments do during wartime, they change the rules to allow them to print what they need rather than impose unpopular taxes trusting that it will all be paid back at some point in the future, and the U.S. followed that pattern to a “T”.
But this time, it affected the whole world, because the removal of gold convertibility of the dollar destroyed the foundation of the Bretton Woods system.
Without a gold backing, there was no hard, physical limit to how many paper dollars could be issued.
Since we now know that all dollars are backed by debt, what do you suppose happened to US debt levels once the externally applied rigor of gold was removed? Let’s find out.
This is a chart of US federal debt from the period of 1949 to 2013. Note that it looks like any other exponential chart we’ve already reviewed.
But especially note what happens after Nixon slammed the gold window – that is, when Nixon removed the last vestige of external physical restraint from the system.
And also note how rapidly the debt levels have climbed recently – these past few years have seen the highest and most rapid accumulation of federal debt in our entire history thanks in large measure to a series of experiments never before attempted in our country’s history – the conduct of two foreign wars AND a tax cut at the same time while printing money out of thin air to finance the enormous structural deficits that resulted.
This rapid accumulation of debt is not a mysterious process at all; rather it is an entirely predictable consequence of the slamming of the gold window.
Remove politicians constraints and they will spend. As far as I know, that’s happened in every country that’s tried it.
How much longer can this continue? Unfortunately there’s no good answer to this besides “as long as foreigners let us”.
A second predictable, and related, consequence concerns the total amount of money in circulation. Remember, all money is loaned into existence so the shape of the federal debt chart should tip you off to the shape of this next chart of US money from the years 1959 to 2013.
The first thing we can note here is that it took our country over three hundred years, from the very first pilgrim until 1973 to generate our first trillion dollars of money stock.
Every road, every bridge and every marketplace on every corner of every town; every boat and every building from the first colony until 350 years later required one trillion dollars of money stock.
Now we are creating a trillion dollars in just under a year.
My question to you is: What will it be like to live here when our nation is creating a trillion dollars every 6 months? How about every 6 weeks? Every 6 hours? 6 minutes?
Where does it stop, if not in hyperinflation and the destruction of the dollar and, by extension, our nation?
If we view these events on a timeline, we can see that the Federal reserve was formed in 1913 and only twenty years later in 1933 our country had entered a form of bankruptcy during which it turned over its collective gold supply, under force of law, to the Federal Reserve.
Eleven years after that the US dollar was enshrined as the world’s reserve currency with an explicit backing by gold. That system was then unilaterally removed by Nixon 27 years later.
In effect, the current global monetary system of un-backed currencies is now roughly 40 years old.
It was not planned, but simply emerged out of a crisis. The unredeemable U.S. dollar remains a popular reserve currency as a matter of convenience, but nothing requires or guarantees that it will retain this role.
It is a safe bet that the next currency system will arise out of some future crisis too.
Only the U.S. is able to use its eroding reserve currency status to borrow and print dollars to pay for its trade deficits.
However, should this abuse create doubts about the dollar’s integrity as a sound reserve currency, the U.S. will be forced to either export more to pay for imports, or take on ever-heavier levels of debt.
If these actions cause the dollar to keep falling, other countries will be tempted to devalue their currencies to keep pace and remain competitive.
In fact, we have already seen such “currency wars” erupt among the major fiat currencies of the world.
The US Fed, the ECB, the Bank of England, the Bank of Japan – all have dramatically increased their sovereign money supplies over the past few years – and no end to the money printing remains in sight.
Every government wants the same thing – as much money as it desires to spend without resorting to increased taxes and a weak currency to keep their exporting businesses happy.
These money printing efforts go by fancy names, such as Quantitative Easing, or QE, and knowing how these work helps us understand why they are really traps that are very hard to get out of once begun.
At least without a lot of painful disruptions.
Please join me for the next chapter on Quantitative Easing.
Publicatie 4 juli 2014
Engelstalige transcriptie Chapter 10 – Quantative easing
Welcome to this chapter on Quantitative Easing, or “QE”.
Here in 2014, the developed world is currently in the middle of the largest monetary experiment in all of history, one that spans the globe.
This is very important because when you strip away a lot of economic gobbled-gook, money is really a social contract. We agree that it has value, but otherwise it is backed by nothing more substantial than that; our mutual agreement.
Given this context, we should view money printing as really more of a social experiment than a sophisticated monetary practice.
And so we’re going to study it here as such because, when a nation’s money system breaks down, society as a whole is impacted. Commerce is heavily disrupted, shelves are cleared, careers are ruined, and the future is badly diminished.
So what exactly is quantitative easing? It’s money printing, simple as that.
However, today we don’t actually print all that much physical cash. So when I say ‘money’ being printed, don’t think of big stacks of one hundred dollar bills; think instead of digital ones and zeros – mainly a lot of zeros – showing up on electronic ledgers.
We discussed QE briefly in the chapter on the Fed, but here we’ll go into it in more detail.
Again, the way the Fed creates money is simply by creating an accounting entry that says the money exists. Imagine if one day you woke up, checked your bank account, and found a billion dollars in it.
Looking into it, you discovered that the Fed had deposited that money there last night.
This money would be very real to you and would completely change your financial circumstances. You could spend it just the same as if you had earned it over sixty-six thousand three hundred and thirteen years working at the current minimum wage of $7.25 per hour and saving every dime.
But where did the Fed get that billion dollars? What did it do to earn that money?
This quote tells the tale.
Let me highlight that last line…
“When you or I write a check there must be sufficient funds in our account to cover the check, but when the Federal Reserve writes a check there is no bank deposit on which that check is drawn. When the Federal Reserve writes a check, it is creating money.”
In our example, the Fed simply created money when it sent it to you. Tap – tap – tap…a few keys were clicked on a keyboard and – voila! – your billion dollars was created and deposited in your account.
At the end of 2013, this process was being used to the tune of $85 billion dollars per month, only that money was not going into your account, not unless you were a very large financial institution.
The Fed creates that money when it buys either Treasury bonds or mortgage-backed securities, which is what “MBS” stands for.
The mechanism is easy to explain. Say the Fed wants to buy $40 billion of Treasury notes. First, it will under the Fed, announce to the market, which means the big banks who play in this game, that it wants to buy $40 billion of Treasury bonds and the price range it is willing to pay.
A variety of banks will then offer up the specific bonds at specific prices and the Fed chooses which among them to actually buy and then buys them.
These bonds are now assets on the Fed’s books. So if we were to take a look at the Fed balance sheet we should see it growing by leaps and bounds over the past few years.
Indeed that’s exactly what we see.
The Fed’s balance sheet is now nearly $ 4 trillion in size, and every single one of the dollars represented by that $4 trillion number was literally printed, or mouse clicked into existence, out of thin air.
Now to really make the point that these are extraordinary and unusual times, I shall point out that the Fed’s balance sheet was only some $880 billion before the economic crisis struck in 2008.
That is, to grease every economic transaction throughout the nation’s entire history up until 2008 required the cumulative injection of $880 billion of circulating base money that the banks could use to lend out via fractional reserve banking.
But since 2008, an additional $3 trillion has been created by the Federal Reserve and injected into the system.
So where did all that newly created money go? Well, we should be able to detect it if we look at a chart of circulating money in our system known as ‘base money.’
And, yep, that’s exactly what we see.
This additional $3 trillion has found its way into various corners and crevices of the financial universe, but the majority of it, around $2.3 trillion is parked right back at the Fed in the form of something called excess reserves.
Recall, banks keep some money in reserve when they make a loan out of deposits and if they keep more than is required that money is called an excess reserve.
So this chart tells us that the Fed has been pumping money into the financial system but the majority of that money has not been made available to Main Street in the form of new loans. Instead it has been idly parked at the Fed earning 0.25% interest.
But this still leaves us with some $700 to $800 billion that has not been parked in the form of excess reserves
Which is out there bidding up stocks, bonds and real estate, mainly due to large institutions buying up vast quantities of all three asset classes using money the Fed printed out of thin air.
This chart showing the relationship between the S&P 500 and Fed printing tells the tale. It’s a safe prediction to make that the US stock market will fall, and fall a lot, if the Fed suddenly stopped printing up money. The stock market is now hooked on this artificial stimulus.
So, how long can this money printing continue? At some point, it needs to stop, right? I mean, we’ll destroy the value of the dollar if we print too many of them. Right?
The answer to this is “yes”. But it’s a lot easier to say than to do.
A huge and poorly understood concern is that this freshly-printed money, once created, is going to be very very difficult to retrieve should that be necessary.
You see, quantitative easing works really well when the money is going out the Fed’s front door, but it’s not going to work very well in reverse.
In fact it may be impossible without crashing the stock and bond markets — creating all sorts of difficulties for both the Fed and our leaders in Washington DC.
Here’s why.
When the Fed is out there buying a huge proportion of something, say Treasury bonds, the price of that asset class is driven up in the marketplace by the demand being artificially created by the Fed.
That’s just Economics 101.
Because the Fed pre-announces its asset purchases, the folks it buys these assets from have a huge advantage. Here’s why.
When the Fed announces it plans to buy a bunch of Treasury bonds, the banks rush out and buy them first. This is called “front running”, Then the banks turn around and sell these very same Treasury bonds to the Fed at a higher price than they bought them for, allowing them to pocket fat profits. Pretty sweet deal, huh?
Everyone is happy playing this game. Show US government enjoys a strong market for its debt, plus gets ultra low interest rates as part of the deal. The banks make big money with no risk. And the Fed gets lots of freshly printed money out into the system further driving down interest rates – which boosts the bond market, the stock market and housing prices.
That’s a win, win, win situation right there. In this scenario, everyone loves the Fed and its magic checkbook, which makes all these popular results possible. Well, at least everyone in power that can skim easy profits from the system.
But now let’s try running that process in reverse. What happens when the Fed decides it’s time to stop flooding the world with free money, and instead attempts to reduce the money supply?
Where the Fed was buying Treasury bonds from the banks at a profit to the banks, when the Fed turns around to sell these same assets back to them, the reverse will, by definition, be true – meaning the banks will be buying Treasury bonds that are falling price, not rising.
The Fed will be demanding money from the banks and in return, will be giving them bonds that it is flooding the market with. Prices in a flooded market only head one direction: downwards.
And at the same time, the US government will still be selling plenty of new bonds into the market. Only now, the Fed won’t be there buying them.
What does this mean? It means that the new bonds from the government, plus the new ones being sold by the Fed will be competing for a dwindling supply of money. And mathematically, that also means that interest rates will be rising.
And as interest rates go up, the bond markets will suffer losses, as will stocks and home prices.
That is, everything the Fed has worked so hard to engineer since the 2008 will be undone. And likely within a very short time period – perhaps just a few months.
If you’ve been wondering why the Fed spent most of 2013 hemming and hawing about whether or not to decrease – or “taper” – its ongoing $85 billion in monthly asset purchases, , this is the main reason. It feared undoing all the years of hard work it spent getting the stock, bond and housing markets to inflate.
But if the Fed cannot easily undo its quantitative easing efforts, then what are the risks we all face?
Well, here’s where history is really quite clear. You can get away with printing for a while, but when it catches up with you, it does so with a vengeance.
The reason is not terribly hard to understand. You cannot print true prosperity. Real wealth does not come from printed money. Real wealth only comes from real people performing actions that create real value.
If it were possible to print up prosperity, every central bank should simply cook up enough new money to hand it out to its citizens and eliminate poverty.
But, of course, that cannot work. Money is not real wealth, it is merely a claim on wealth. You can make as many claims as you wish, but the amount of real stuff remains the same and will shrink in relation to all that printed money.
Quantitative easing and the other central bank shenanigans of the past several years are not ordinary. They aren’t normal and they haven’t been tried before. They signal a huge and abnormal departure from everything we know about what works and doesn’t work economically.
We’ll each need more to our wealth strategies besides complacency and hope.
Perhaps this time is different. But if not (and it almost never is), then we should all be crystal clear on the risks.
At the exponential pace at which the Fed is increasing the money supply, and knowing the huge challenges the Fed – and most other world central banks – face in trying to stop or even slow down their money printing, the potential for a disruptive global inflationary period is very real.
Publicatie 4 juli 2014