Eternal Bliss: Monetisation of debt and Fed

Wednesday, May 19, 2010

Monetisation of debt and Fed

In 2003, in the midst of rising fears of deflation, B. Bernanke, Federal Reserve Board member, created quite a stir with his observation in financial circles:

Like gold, U.S. dollars have value only to the extent that they are strictly limited in supply. But the United States government has a technology, called a printing press, or today, its electronic equivalent, that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation...

With that statement, Bernanke said more than what the government wante people to know. The ways of Washington and the Federal Reserve could even be more profligate if need be, so, let’s not get ourselves all worried up with something as loathsome as a deflation. When Bernanke alluded to the printing press... or its electronic equivalent, he was referring to the process of monetization.

Monetization and the inner sanctum of government finance are quite often mentioned in such arcane, highly specialized language that few people – including other economists- understand what the writer is trying to convey. To simplify the terms, monetization amounts to nothing more than printing money. It works the following manner: when the federal government can’t seem to find domestic or foreign buyers for its debt issue, usually because the interest rate is not high enough to attract lenders – a particularly acute dilemma in a low-interest-rate environment, the Federal Reserve Bank buys this debt and issues a check to the government. The government spends this money and in turn debases all the currency outstanding.

This is a sophistication of a process first used by the Roman empire. They would take Roman aureus into the treasury as tax payments, shave some gold off the edges, remelt the shavings and mint them into more coins. The debased coins and the new coins would then be recirculated as equivalent in value the quantity of gold in circulation was not increased, only the number of aureii. Since an increasing supply of aureii was chasing roughly the same amount of goods, the net result was one of the first forms of currency inflation.

The modern Federal Reserve is engaged in much the same process when it monetizes debt. The most likely times for inflationary outbursts are the eighteen to twenty-four months following a presidential election. Federal Reserve chairmen, either named by Democratic or Republican administrations, have a tendency to monazite more debt previous to a presidential election in order to maintain interest rates low and the economy moving the right direction. A rising inflation rate in the ensuing years is the direct cost. The greatest inflation’s have been those following elections. The nineteen seventy-three to nineteen seventy-four outburst followed the nineteen seventy-two election year. The nineteen seventy-seven to nineteen seventy-nine outburst followed the nineteen seventy-six election. Even during the disinflationary nineteen eighties, the inflation rate jumped proportionately following the 1984 and 1988 elections.

In 1992, a record, thirty eight billion dollars was monetized by the Federal Reserve, belying claims by some political pundits that George H.W. Bush lost due to the fact that the Fed didn’t accommodate his reelection. By way of comparison. Fourteen billion dollars were monetized in nineteen ninety and twenty-four billion dollars in nineteen ninety-one. It is more than understood that in the months previous to the two thousand-four election, the Fed went the extra mile to accommodate the goal of getting George W. Bush reelected, and it remains to be seen what that accommodation could possibly produce in terms of inflation from two thousand-five onward. During the spring of two thousand-four, before the electioneering had even started, American consumers were already being subjected to record gasoline prices among other inflation manifestations.

In addition to the efforts of the fed to stimulate the economy, another additional inflationary motor is in process that, at this time, only a small amount of analysts have started to unravel. That this is the process of indirect monetization happening now in the United States through government bond purchases by exporting nation-states like China and Japan. This is an even more lethal and virulent form of inflation because the Federal Reserve has lost control of the money-printing process.

The meaning of this isthat how much inflation will be created in the United States is now strongly influenced by Japan, China, and other exporting nations, and the interest that they have in mind are their own, not the same interests as those of the United States. It is not certain how this could all possibly settle out in the economy of the United States, but let’s just put it this way: the task before fed chairman Alan Greenspan is very threatening and more different than anything faced by former fed chairmen. The United States could lose its control of its own monetary policy, and that is a scary proposition, to say the least. Commodity prices are already going up strongly – maybe an indication of what lies ahead, not only for the American economy but also for the economies around the earth.

Gold Mining & Gold Prospecting Investing in Gold Using Gold and Silver as Money The Effects of the Deficit on the Economy Gold and United States' Debt