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What's Really Behind Quantitative Easing QE2? The Looming Threat
of a Crippling Debt Service
By Ellen Brown
URL of this article:www.globalresearch.ca/index.php?context=va&aid=22014
Global Research, November 20, 2010 webofdebt.com - 2010-11-19
The deficit hawks are circling, hovering over QE2, calling it just
another inflationary bank bailout. But unlike QE1, QE2 is not about
saving the banks. Its about funding the federal deficit without
increasing the interest tab, something that may be necessary in
this gridlocked political climate just to keep the government
functioning.
On November 15, the Wall Street Journal published an open letter
to Fed Chairman Ben Bernanke from 23 noted economists, professors
and fund managers, urging him to abandon his new quantitative easing
policy called QE2. The letter said:
We believe the Federal Reserves large-scale asset purchase plan
(so-called quantitative easing) should be reconsidered and discontinued.
. . . The planned asset purchases risk currency debasement and
inflation, and we do not think they will achieve the Feds objective
of promoting employment.
The Pragmatic Capitalist (Cullen Roche) remarked:
Many of the people on this list have been warning about bond
vigilantes while also comparing the USA to Greece for several years
now. Of course, theyve been terribly wrong and it is entirely due
to the fact that they do not understand how the US monetary system
works. . . . Whats unfortunate is that these are many of our best
minds. These are the people driving the economic bus.
The deficit hawks say QE is massively inflationary; that it is
responsible for soaring commodity prices here and abroad; that QE2
wont work any better than an earlier scheme called QE1, which was
less about stimulating the economy than about saving the banks; and
that QE has caused the devaluation of the dollar, which is hurting
foreign currencies and driving up prices abroad.
None of these contentions is true, as will be shown. They arise
from a failure either to understand modern monetary mechanics (see
links at The Pragmatic Capitalist and here) or to understand QE2,
which is a different animal from QE1. QE2 is not about saving the
banks, or devaluing the dollar, or saving the housing market. It
is about saving the government from having to raise taxes or cut
programs, and saving Americans from the austerity measures crippling
the Irish and the Greeks; and for that, it may well be the most
effective tool currently available. QE2 promotes employment by
keeping the government in business. The government can then work
on adding jobs.
The Looming Threat of a Crippling Debt Service
The federal debt has increased by more than 50% since 2006, due to
a collapsed economy and the highly controversial decision to bail
out the banks. By the end of 2009, the debt was up to $12.3 trillion;
but the interest paid on it ($383 billion) was actually less than
in 2006 ($406 billion), because interest rates had been pushed to
extremely low levels. Interest now eats up nearly half the governments
income tax receipts, which are estimated at $899 billion for FY
2010. Of this, $414 billion will go to interest on the federal
debt. If interest rates were to rise just a couple of percentage
points, servicing the federal debt would consume over 100% of current
income tax receipts, and taxes might have to be doubled.
As for the surging commodity and currency prices abroad, they are
not the result of QE. They are largely the result of the U.S.
dollar carry trade, which is the result of pressure to keep interest
rates artificially low. Banks that can borrow at the very low fed
funds rate (now 0.2%) can turn around and speculate abroad, reaping
much higher returns.
Interest rates cannot be raised again to reasonable levels until
the cost of servicing the federal debt is reduced; and today that
can be done most expeditiously through QE2 -- monetizing the debt
through the Federal Reserve, essentially interest-free. Alone among
the governments creditors, the Fed rebates the interest to the
government after deducting its costs. In 2008, the Fed reported
that it rebated 85% of its profits to the government. The interest
rate on the 10-year government bonds the Fed is planning to buy is
now 2.66%. Fifteen percent of 2.66% is the equivalent of a 0.4%
interest rate, the best deal in town on long-term bonds.
A Reluctant Fed Steps Up to the Plate
The Fed was strong-armed into rebating its profits to the government
in the 1960s, when Wright Patman, Chairman of the House Banking and
Currency Committee, pushed to have the Fed nationalized. According
to Congressman Jerry Voorhis in The Strange Case of Richard Milhous
Nixon (1973):
As a direct result of logical and relentless agitation by members
of Congress, led by Congressman Wright Patman as well as by other
competent monetary experts, the Federal Reserve began to pay to the
U.S. Treasury a considerable part of its earnings from interest on
government securities. This was done without public notice and few
people, even today, know that it is being done. It was done, quite
obviously, as acknowledgment that the Federal Reserve Banks were
acting on the one hand as a national bank of issue, creating the
nations money, but on the other hand charging the nation interest
on its own credit which no true national bank of issue could
conceivably, or with any show of justice, dare to do.
Voorhis went on, But this is only part of the story. And the less
discouraging part, at that. For where the commercial banks are
concerned, there is no such repayment of the peoples money. Commercial
banks do not rebate the interest, said Voorhis, although they also
buy the bonds with newly created demand deposit entries on their
books nothing more.
After the 1960s, the policy was to fund government bonds through
commercial banks (which could collect interest) rather than through
the central bank (which could not). This was true not just in the
U.S. but in other countries, after a quadrupling of oil prices
combined with abandonment of the gold standard produced stagflation
that was erroneously blamed on governments printing money.
Consistent with that longstanding policy, Chairman Bernanke initially
resisted funding the federal deficit. In January 2010, he admonished
Congress:
"We're not going to monetize the debt. It is very, very important
for Congress and administration to come to some kind of program,
some kind of plan that will credibly show how the United States
government is going to bring itself back to a sustainable position."
His concern, according to The Washington Times, was that the impasse
in Congress over tough spending cuts and tax increases needed to
bring down deficits will eventually force the Fed to accommodate
deficits by printing money and buying Treasury bonds.
That impasse crystallized on November 3, 2010, when Republicans
swept the House. There would be no raising of taxes on the rich,
and the gridlock in Congress meant there would be no budget cuts
either. Compounding the problem was that over the last six months,
China has stopped buying U.S. debt, reducing inflows by about $50
billion per month.
QE2 Is Not QE1
In QE1, the Fed bought $1.2 trillion in toxic mortgage-backed
securities off the books of the banks. QE1 mirrored TARP, the
governments Troubled Asset Relief Program, except that TARP was
funded by the government with $700 billion in taxpayer money. QE1
was funded by the Federal Reserve with computer keystrokes, simply
by crediting the banks reserve accounts at the Fed.
Pundits were predicting that QE2 would be more of the same, but it
turned out to be something quite different. Immediately after the
election, Bernanke announced that the Fed would be using its power
to purchase assets to buy federal securities on the secondary market
-- from banks, bond investors and hedge funds. (In the EU, the
European Central Bank began a similar policy when it bought Greek
bonds on the secondary market.) The bond dealers would then be
likely to use the money to buy more Treasuries, increasing overall
Treasury sales.
The bankers who applauded QE1 were generally critical of QE2,
probably because they would get nothing out of it. They would have
to give up their interest-bearing bonds for additional cash reserves,
something they already have more of than they can use. Unlike QE1,
QE2 was designed, not to help the banks, but to relieve the pressure
on the federal budget.
Bernanke said the Fed would buy $600 billion in long-term government
bonds at the rate of $75 billion per month, filling the hole left
by China. An estimated $275 billion would also be rolled over into
Treasuries from the mortgage-backed securities the Fed bought during
QE1, which are now reaching maturity. More QE was possible, he
said, if unemployment stayed high and inflation stayed low (measured
by the core Consumer Price Index).
Addison Wiggin noted in his November 4 Five Minute Forecast that
this essentially meant the Fed planned to monetize the whole deficit
for the next eight months. He quoted Agora Financials Bill Bonner:
If this were Greece or Ireland, the government would be forced to
cut back. With quantitative easing ready, there is no need to face
the music.
That was meant as a criticism, but you could also see it as a very
good deal. Why pay interest to foreign central banks when you can
get the money nearly interest-free from your own central bank? In
eight months, the Fed will own more Treasuries than China and Japan
combined, making it the largest holder of government securities
outside the government itself.
The Overrated Hazard of Inflation
The objection of the deficit hawks, of course, is that this will
be massively inflationary, diluting the value of the dollar; but a
close look at the data indicates that these fears are unfounded.
Adding money to the money supply is obviously not hazardous when
the money supply is shrinking, and it is shrinking now. Financial
commentator Charles Hugh Smith estimates that the economy faces $15
trillion in writedowns in collateral and credit, based on projections
from the latest Fed Flow of Funds. The Fed's $2 trillion in new
credit/liquidity is therefore insufficient to trigger either inflation
or another speculative bubble.
In any case, Chairman Bernanke maintains that QE involves no printing
of new money. It is just an asset swap on the balance sheets of
the bondholders. The bondholders are no richer than before and
have no more money to spend than before.
Professor Warren Mosler explains that the bondholders hold the bonds
in accounts at the Fed. He says, U.S. Treasury securities are
accounted much like savings accounts at a normal commercial bank.
They pay interest and are considered part of the federal debt. When
the debt is paid by repurchasing the bonds, all that happens is
that the sums are moved from the bondholders savings account into
its checking account at the Fed, where the entries are no longer
considered part of the national debt. The chief difference is that
one account bears interest and the other doesnt.
What About the Inflation in Commodities?
Despite surging commodity prices, the overall inflation rate remains
very low, because housing has to be factored in. The housing market
is recovering in some areas, but housing prices overall have dropped
28% from their peak. Main Street hasnt been flooded with money;
the money has just shifted around. Businesses are still having
trouble getting reasonable loans, and so are prospective homeowners.
As for the obvious price inflation in commodities -- notably gold,
silver, oil and food -- what is driving these prices up cannot be
an inflated U.S. money supply, since the money supply is actually
shrinking. Rather, it is a combination of factors including (a)
heavy competition for these scarce goods from developing countries,
whose economies are growing much faster than ours; (b) the flight
of hot money from the real estate market, which has nowhere else
to go; (c) in the case of soaring food prices, disastrous weather
patterns; and (d) speculation, which is fanning the flames.
Feeding it all are the extremely low interest rates maintained by
the Fed, allowing banks and their investor clients to borrow very
cheaply and invest where they can get a much better return than on
risky domestic loans. This carry trade will continue until something
is done about the interest tab on the federal debt.
The ideal alternative would be for a transparent and accountable
government to issue the money it needs outright, a function the
Constitution reserves to Congress; but an interest-free loan from
the Federal Reserve rolled over indefinitely is the next best thing.
A Bold Precedent
QE2 is not a helicopter drop of money on the banks or on Main Street.
It is the Fed funding the government virtually interest-free,
allowing the government to do what it needs to do without driving
up the interest bill on the federal debt an interest bill that
need not have existed in the first place. As Thomas Edison said,
If our nation can issue a dollar bond, it can issue a dollar bill.
The element that makes the bond good, makes the bill good, also.
The Fed failed to revive the economy with QE1, but it could redeem
itself with QE2, a bold precedent that might inspire other countries
to break the chains of debt peonage in the same way. QE2 is the
functional equivalent of what many countries did very successfully
before the 1970s, when they funded their governments with interest-free
loans from their own central banks.
Countries everywhere are now suffering from debt deflation. They
could all use a good dose of their own interest-free national credit,
beginning with Ireland and Greece.
Ellen Brown is an attorney and the author of eleven books. In Web
of Debt: The Shocking Truth About Our Money System, 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.
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