Saturday, October 26, 2013

word is bond...,


pbs | Paul Solman: If you've been reading from question one, here now we get to the agency of the government that actually creates our money, and thereby tries to control inflation: the Federal Reserve. It creates U.S. dollars not by printing them, but by generating them electronically as deposits in our banks, deposits known as "Federal reserves." 

The Fed doesn't just give the reserves to the banks, however. It uses them to buy some of what the banks have in abundance: bonds.

And what are bonds? Legal debt contracts, as in "my word is my bond, but just in case you don't take my word as Gospel, here's a written promise that I'll pay you back." 

Banks are in the business of taking money from depositors and lending it out. Often they lend to individuals and small businesses. Other times, they lend to large institutions or governments. Those loans are usually made in return for bonds -- IOUs. So banks have lots of them.

The world's biggest issuer of bonds is the U.S. government, which has run up a cumulative $16 trillion national debt. As a result, the U.S. has $16 trillion worth of bonds outstanding. U.S. banks hold a significant portion of them.

When the Fed wants to spur the economy, as I explained in my answer to the first question, above, it buys bonds from the Treasury, thus injecting its "Federal reserves" into the banking system, which can then lend out most of the new money as loans and spur economic activity. That's what the Fed has been doing ever since the Crash of '08.

Look at the Fed's situation six years ago, in October of 2007. It held about $800 billion worth of U.S. Treasury IOUs, meaning it was financing less than a trillion dollars worth of U.S. debt. As of this week, that number had swelled to $2.2 trillion, with the Fed having bought another $1.5 trillion worth of mortgage-backed securities (housing loans) as well. So yes, Yan, the Fed is now the proud owner of nearly $4 trillion dollars worth of loans.

All told, the Fed has newly taken on about $3 trillion worth of loans since the Crash of '08, which it paid for with newly created electronic "Federal reserves." That's the policy known as "quantitative easing," so-called because the Fed increased the quantity of money in the banking system in order to ease ( as opposed to "tighten") economic activity. And to be clear: this is what the Fed has always done when it tried to stimulate the economy. The Fed was blasted by conservative economists Milton Friedman and Anna Schwartz for not having done so in the early 1930s and thus having contributed mightily to the Great Depression by failing to ease.

The talk now is that the Fed will slow and eventually stop its bond buying and money creation -- gradually. It will, in short, taper off its easing, as it typically has done in the past. 

Yan asks a question beyond tapering, however: If the Fed were to start selling its bonds instead of continuing to buy them, wouldn't that flood the bond market with U.S. Treasuries, making it more difficult for the Treasury to borrow money by selling new bonds of its own and indeed forcing the Treasury to offer a higher interest rate to get anyone to lend to it?

Well, yes, which is why the Fed will only start selling bonds when it wants to tighten the economy -- should it show signs of overheating and bubble-like activity. Those signs would presumably show up first in lots of buying and price and wage rises and thus, a sudden spurt in the inflation rate. To "taper," in short, does not mean "to suddenly reverse course."

Yan also asks: "Could [the Fed] give [the Treasury bonds] to the main part of the government? What would the bonds be if that happened? Mad money?"

I'm no finance lawyer, but the answer is almost surely "no." I can't imagine that the Fed has authority to simply give away its assets. And why would the Treasury need the bonds? It has nothing to fear from the Fed. If the Fed holds Treasury bonds, it's not likely to dump them, is it? Not unless the economy needs dramatic tightening, that is, in which case the Treasury should be happy to see the Fed start unloading.

But let me ask a question you didn't pose, Yan: what happened to the nearly $3 trillion dollars the Fed has created between 2008 and today? 

Well, look again at the Fed balance sheet. In the second section, entitled "1. Factors Affecting Reserve Balances of Depository Institutions (continued)," the seventh row is labeled "Reserve balances with Federal Reserve Banks." Up until the Crash of '08, that number was in the low billions. Today, as you can see if you look, it's $2.3 trillion.

In other words, most of the money the Fed has created -- "out of thin air," as Fedophobes like to declaim -- is right back at the Fed in the form of deposits by banks. 

"But why would that be?" you might well ask.

And the answer is this: at the time of the Crash, the Fed instituted a policy of paying the banks to redeposit money at the Fed. That payment is known as "Interest on Excess Reserves" (IOER). It appears to have been a way of discouraging banks from making risky loans, a way of keeping the newly created Fed money from circulating throughout the economy and thus creating inflation. In fact, some observers would say its main purpose was simply to shore up the wobbly banking system with Fed money. I wouldn't disagree.

Janice Bienn -- Dallas, Texas: What are your thoughts on the video "Money as Debt" by Paul Grignon? I sent someone your article, and he fired back with this video, stating that you were either ill informed, or part of the "conspiracy." I don't believe either conclusion is true. But I would appreciate some clarification. Thanks in advance for your time.

Paul Solman: I don't mean to sound defensive, Janice, but if even I am ill informed, after all these decades of time and effort, we might as well go fishing and leave the economy to -- well, whom, exactly? Paul Grignon? His great insight, as near as I can tell, is that money is debt -- true -- and debt is bad. Really? Debt is bad? Money is bad?

Look, debt can be abused. Who would doubt it? The ability to create money can be abused. Again, who would argue otherwise? But for goodness sake, everything of value can be abused, from land to love to food to friendship! 

The easiest form of communication, I discovered early in my career, is to denounce, to deride, to find flaws. That's because pretty much nothing in this all-too-human world of ours works quite as intended. 

People and larger groups of people (institutions) and even larger groups (governments) take on financial commitments they can't meet. What else is new? This has been happening throughout the entire course of financial transactions. Here's the translation of a message on a clay tablet, in cuneiform, from A. Leo Oppenheim's book, "Letters from Mesopotamia":
From Silla-Labbum and Elani

Tell Puzur-Assur, Amua, and Assur-samsi:

Thirty years ago you left the city of Assur [one of the capitals of ancient Assyria, 250 or so miles north of Baghdad]. You have never made a deposit since, and we have not recovered one shekel of silver from you, but we have never made you feel bad about this. Our tablets have been going to you with caravan after caravan, but no report from you has ever come here. We have addressed claims to your father but we have not been claiming one shekel of your private silver. Please, do come back right away; should you be too busy with your business, deposit the silver for us. (Remember) we have never made you feel bad about this matter but we are now forced to appear, in your eyes, acting as gentlemen should not. Please, do come back right away or deposit the silver for us.
If not, we will send you a notice from the local ruler and the police, and thus put you to shame in the assembly of the merchants. You will also cease to be one of us.
I suppose it's possible to attribute the fall of Assyrian hegemony to widespread debt abuse. But personally, I'd be more inclined to believe that cross-desert commerce was good for the Mesopotamian economy -- the world's very first economy, some say -- and that such commerce was facilitated by debt and money, as all commerce has been ever since. If that makes me part of a conspiracy, so be it.