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A Solution to the Federal Debt Crisis? Time for Helicopter Ben to
Drop Some Money on Mainstream
By Ellen Brown
URL of this article:www.globalresearch.ca/index.php?context=va&aid=20962
Global Research, September 9, 2010 webofdebt.com
The Fed is proposing another round of quantitative easing, although
the first round failed to reverse deflation. It failed because the
money went into the coffers of banks, which failed to lend it on.
To reverse deflation, the money needs to be funneled directly to
state and local economies. The Fed may not be authorized to monetize
state bonds, but it COULD buy bonds issued by state-owned banks.
In 2002, in a speech that earned him the nickname Helicopter Ben,
then-Fed Governor Bernanke famously said that the government could
easily reverse a deflation, just by printing money and dropping it
from helicopters. The U.S. government has a technology, called a
printing press (or, today, its electronic equivalent), he said,
that allows it to produce as many U.S. dollars as it wishes at
essentially no cost. Later in the speech he discussed a money-financed
tax cut, which he said was essentially equivalent to Milton Friedmans
famous helicopter drop of money. You could cure a deflation, said
Professor Friedman, simply by dropping money from helicopters.
It seems logical enough. If there is insufficient money in the
money supply (deflation), the solution is to put more money into
it. But if deflation is so easy to fix, then why has the Feds
massive attempts to date failed to do the job? At the Federal
Reserves Jackson Hole summit on August 27, Chairman Bernanke said
he would fight deflation with his whole arsenal, including quantitative
easing (QE) purchasing longterm securities with money created on
a computer. Yet since 2008, the Fed has added more than $1.2
trillion to base money doing just that, and the economy is still
in a serious deflationary spiral. In the first quarter of this
year, the money supply actually shrank at a record annual rate of
9.6%.
Cullen Roche at The Pragmatic Capitalist has an answer to that
puzzle. He says that as currently practiced, quantitative easing
(QE) is not really a money drop. It is just an asset swap:
[T]he Fed doesnt actually print anything when it initiates its QE
policy. The Fed simply electronically swaps an asset with the
private sector. In most cases it swaps deposits with an interest
bearing asset.
The Fed just swaps Federal Reserve Notes (dollar bills) for other
assets (promissory notes or debt) that can quickly be turned into
money. The Fed is merely trading one form of liquidity for another,
without raising the overall water level in the pool.
The mechanics of how QE works were revealed in a remarkable segment
on National Public Radio on August 26, describing how a team of Fed
employees bought $1.25 trillion in mortgage bonds beginning in late
2008. According to NPR:
The Fed was able to spend so much money so quickly because it has
a unique power: It can create money out of thin air, whenever it
decides to do so. So . . . the mortgage team would decide to buy
a bond, theyd push a button on the computer and voila, money is
created.
The thing about bonds, of course, is that people pay them back. So
that $1.25 trillion in mortgage bonds will shrink over time, as
they get repaid. Earlier this month, the Fed announced that it
will use the proceeds from the mortgage bonds to buy Treasury bonds
essentially keeping all that newly created money in circulation.
The decision was a sign that the Fed thinks the economy still needs
to be propped up with extraordinary measures.
Extraordinary measures was a reference to Section 13(3) of the
Federal Reserve Act, which allows the Fed in unusual and exigent
circumstances to buy notes, drafts and bills of exchange (debt
instruments) from any individual, partnership or corporation
satisfying its requirements. The Fed was supposedly engaging in
these extraordinary measures to reflate the money supply and get
credit flowing again. Yet the money supply continued to shrink.
The problem, as Roche explains, is that the dollars were merely
being swapped for other highly liquid assets on bank balance sheets.
That this sort of asset swap will not pump up a collapsed money
supply has been shown not only by the Feds failed experiments over
the last two years but by two decades of failed QE policy in Japan,
an economy which remains in the deflationary doldrums. To reverse
deflation, it seems, QE needs to be directed somewhere else besides
the balance sheets of private banks. What we need is the sort of
helicopter drop described by Bernanke in 2002 one over the towns
and cities of the real economy.
There is another interesting lesson suggested by two decades of
failed QE: it might actually be possible for the government to print
its way out of debt, without triggering the dreaded hyperinflation
long warned of by pundits. Swapping dollars for debt hasnt inflated
the circulating money supply to date because federal debt securities
already serve as forms of money in the economy.
The Textbook Money Multiplier Model . . . And Why It Is Obsolete
Beginning with some definitions, quantitative easing is explained
in Wikipedia like this:
A central bank . . . first credit[s] its own account with money it
has created ex nihilo (out of nothing). It then purchases financial
assets, including government bonds, mortgage-backed securities and
corporate bonds, from banks and other financial institutions in a
process referred to as open market operations. The purchases, by
way of account deposits, give banks the excess reserves required
for them to create new money, and thus a hopeful stimulation of the
economy, by the process of deposit multiplication from increased
lending in the fractional reserve banking system.
Deposit multiplication is the textbook explanation for how credit
expands as it circulates through the economy. In the textbook
model, banks must retain reserves equal to 10% of outstanding
deposits (including deposits created as loans). With a 10% reserve
requirement, a $100 deposit can support a $90 loan, which gets
deposited in another bank, where it becomes an $81 loan, and so
forth, until a $100 deposit becomes $1,000 in credit-money.
The theory is that increasing the banks reserves will stimulate
this process, but both the Federal Reserve and the Bank for
International Settlements (BIS) now concede that the process has
not been working in the textbook way. (The BIS is the central
bankers central bank in Basel, Switzerland.) The futile effort to
push more money into bloated bank reserve accounts has been compared
to adding more apples to shelves that are already overstocked with
apples. Adding more reserves to a banking system that already has
more reserves than it can use has no net effect on the money supply.
The failure of QE either to increase bank lending or to inflate the
money supply was confirmed in a March 24 paper by Federal Reserve
Vice Chairman Donald L. Kohn, who wrote:
The huge quantity of bank reserves that were created [by quantitative
easing] has been seen largely as a byproduct of the purchases [of
debt instruments] that would be unlikely to have a significant
independent effect on financial markets and the economy. This view
is not consistent with the simple models in many textbooks or the
monetarist tradition in monetary policy, which emphasizes a line
of causation from reserves to the money supply to economic activity
and inflation.
The textbook model is obsolete because banks dont make lending
decisions based on how many reserves they have. They can always
get the reserves they need. If customers dont walk in the door
with new deposits, the bank can borrow deposits from other banks,
something they can now do at the very low Fed funds rate of .2%
(1/5th of 1%). And if those deposits are not available, the Federal
Reserve itself will supply the reserves. This was confirmed in a
BIS working paper called Unconventional Monetary Policies: An
Appraisal, which observed:
[T]he level of reserves hardly figures in banks lending decisions.
The amount of credit outstanding is determined by banks willingness
to supply loans, based on perceived risk-return trade-offs, and by
the demand for those loans. . . .
The aggregate availability of bank reserves does not constrain the
expansion [of credit] directly. The reason is simple: . . . in order
to avoid extreme volatility in the interest rate, central banks
supply reserves as demanded by the system. From this perspective,
a reserve requirement, depending on its remuneration, affects the
cost . . . of loans, but does not constrain credit expansion
quantitatively. . . . [A]n expansion of reserves in excess of any
requirement does not give banks more resources to expand lending.
It only changes the composition of liquid assets of the banking
system. Given the very high substitutability between bank reserves
and other government assets held for liquidity purposes, the impact
can be marginal at best.
Again, one form of liquidity is just substituted for another, without
changing the overall level in the pool.
If bank reserves do not constrain bank lending, what does? According
to the BIS paper, the main . . . constraint on the expansion of
credit is minimum capital requirements. These capital requirements,
known as Basel I and Basel II, were imposed by the BIS itself. It
is interesting that the BIS knows that the main constraints on bank
lending are its own capital requirements, yet it is talking about
raising them, in an economic climate in which lending is already
seriously impaired. Either the BIS is talking out of both sides
of its mouth, or its writers dont read each other.
A Solution to the Federal Debt Crisis?
Another interesting aside arising from all this is the suggestion
that the government could actually print its way out of debt it
could print dollars and buy back its bonds -- without creating
inflation. As Roche observes:
[Quantitative easing] in time of a balance sheet recession is not
actually inflationary at all. With the government merely swapping
assets they are not actually printing any new money. In fact, the
government is now essentially stealing interest bearing assets from
the private sector and replacing them with deposits. . . . [T]his
policy response would in fact be deflationary not inflationary.
Roche concludes, the inflationistas have been wrong and the USA
defaultistas have been horribly wrong. The inflationistas are the
pundits screaming that QE will end in hyperinflation, and the
defaultistas are those insisting that the U.S. must eventually
default on its debt. Representing both camps, for example, is
Richard Russell, who writes:
In my opinion, the US MUST default on its debt. There are two ways
to default. One is simply to renege on the debt. . . . The other
way to default on the debt is to inflate it away. Im absolutely
convinced that this is the path that the US will take. If the US
inflates enough, then over time (many years) the devalued dollar
will tend to reduce the power of the debts.
The failed QE experiments in Japan and the U.S. suggest, however,
that there is a third alternative. Printing dollars to pay the
debt (referred to by Russell as inflating the debt away) might
actually eliminate the debt without creating inflation. This is
because federal bonds and Federal Reserve Notes are interchangeable
forms of liquidity. Government securities trade around the world
just as if they were money. A $100 bond represents a claim on $100
worth of goods and services, just as a $100 bill does. The difference,
as Thomas Edison said nearly a century ago, is merely that the bond
lets money brokers collect twice the amount of the bond and an
additional 20%, whereas the currency pays nobody but those who
contribute directly in some useful way. . . . Both are promises to
pay, but one promise fattens the usurers and the other helps the
people.
The Feds earlier attempts at QE involved swapping $1.25 trillion
in mortgaged-backed securities (MBS) for dollars created on a
computer screen. As noted in the NPR segment, many of those
securities have come due and have gotten paid off, putting cash in
the Feds till. The Fed now proposes to use this money to buy
long-term Treasury debt rather than MBS. That means the Fed will,
in effect, be buying the governments debt with dollars created on
a computer screen. The privately-owned Federal Reserve is not
actually an arm of the federal government, but if it were, the
government would thus be printing its way out of debt just as
Helicopter Ben proposed in 2002. Recall that he said, the U.S.
government has a technology, called a printing press the U.S.
government, not the central bank that has done all the QE to date.
Running the governments printing presses to pay its bills has not
seriously been tried since the Civil War, when President Lincoln
saved the North from a crippling war debt at usurious interest rates
by printing Greenbacks (U.S. Notes). Other countries, however,
have tested and proven this model more recently. They include
Germany, which pulled itself out of a massive financial collapse
in the early 1930s by printing a form of currency called MEFO bills;
and Australia, New Zealand and Canada, all of which successfully
funded public works in the first half of the twentieth century
simply by advancing the credit of the nation. China, Malaysia,
Guernsey, Jersey, India, Argentina and other countries have also
revived their economies at critical times by this means. The U.S.
government could do this too. It could print dollars (or type them
into electronic bank accounts) and spend the money on the sorts of
local public projects that would put people back to work and get
the economy rolling again.
How to Reverse a Deflation:
Do a Helicopter Drop on the States
The government could pay its bills by issuing Greenbacks as Lincoln
did, but it probably wont, given the current deadlock in Congress.
Today only the Federal Reserve Chairman seems to be in a position
to act unilaterally, without asking anyones permission. Chairman
Bernanke could execute his own plan and generate the credit needed
to get the economy churning again, by aiming his quantitative easing
tool at the states. After all, if Wall Street (which got us into
this mess) can borrow at .2%, underwritten by the Fed as lender of
last resort, then state and local governments should be able to as
well. Chairman Bernanke could credit the Feds account with money
created ex nihilo (out of nothing) and swap it for state and municipal
bonds at the Fed funds rate.
A state might not qualify as an individual, partnership or corporation
under Section 13(3) of the Federal Reserve Act, but a state-owned
bank would. Bruce Cahan, an attorney and social entrepreneur in
Silicon Valley, California, proposes that the Fed could diversify
its role by buying long-term bonds in existing or newly-chartered
state-owned banks. These banks, which would have a mandate to serve
state and local communities, would more quickly and accountably
lend for in-state purposes than private banks do now. They could
be required to use accepted transparency accounting standards to
trace how the proceeds of their loans flowed into the economy.
Local needs would thus determine how best to jumpstart and keep
alive businesses and households that the too big to fail megabanks
no longer want to fund on fair credit terms. Adding a state-owned
bank would also bring competition to regional banking markets such
as that of the San Francisco Bay area, which are now dominated by
out-of-state megabanks. By funding state-owned banks, the Fed could
inject liquidity where it is most needed, in local markets where
workers are hired and real goods and services are sold.
Ellen Brown is an attorney and the author of eleven books. In Web
of Debt, her latest book, she shows how the Federal Reserve and
"the money trust" have usurped the power to create money from the
people themselves, and how we the people can get it back. Her
websites are webofdebt.com, ellenbrown.com, and public-banking.com.
Read Ellen Brown's chapter on the Economic Crisis
NEW BOOK FROM GLOBAL RESEARCH (click for details) The Global Economic
Crisis
Michel Chossudovsky Andrew G. Marshall (editors)
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Copyright Ellen Brown, webofdebt.com, 2010
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