“The year 3434, of the Second Age. Here follows the account of Isildur, High King of Gondor, and the finding of the Ring of Power. The One Ring, which shall be an heirloom of my kingdom. All those who follow in my bloodline shall be bound to its fate, for I will risk no hurt to the Ring. It is precious to me, though I buy it with a great pain. The markings upon the band begin to fade. The writing which at first was as clear as red flame, has all but disappeared, a secret now that only fire can tell.” – The Lord of the Rings, the Fellowship of the Ring
Last week Ben Bernanke, chairman of the Federal Reserve Bank, announced another round of “Quantitative Easing” where the Fed “prints” money to buy various bank notes, bonds, treasuries, and the like. This is by some accounts “QE3” – or the third round of Quantitative Easing – and by others “QE-infinity” as it is open-ended bond buying. It is, to say the least, a big mess.
The Meaning of Money …
The meaning and purpose of money has been discussed in many places in times past, and now new discernment will be gained here. Money has several characteristics, all of which it holds (or should) at the same time. Money is a medium of exchange. Because people are differently talented it is imminently useful that we each focus on our particular productive skills and exchange that production with one another. In order that pig farmers and book-shelf makers can maximize their productivity and their efficiency of consumption of that productivity (building what you are good at building but consuming what you want to consume) we need a medium of exchange so they are not stuck with the inefficiencies of barter. Thus, we have money.
Money is also then a store of value. If I exchange my production for otherwise useless currency (no matter how shiny they are, you cannot eat gold coins) I must have some guarantee that it will not lose value if I wait until tomorrow to spend it (exchange it) for someone else’s production. If I have 50-widgets worth of money today, I do not want to find that tomorrow it is only worth 32 widgets.
Through these modes of operation, we have come to understand money as a “promise to pay”. I give you 50-widgets worth of money which you can exchange later for 50 widgets (or some other, equivalently-valued thing). It is of little relevance that you exchange it with me for 50 widgets that I built myself at that later date. All that matters is that somewhere along the way a promise to supply 50-widgets worth of production is satisfied.
Cash and Credit …
Viewed as a “promise to pay” money in cash and money in credit are of no distinction. One is a promise by the Federal Reserve to pay (these are Federal Reserve notes), and one is a promise to deliver a promise by the Federal Reserve to pay. It is largely a difference without distinction. It is for this reason that folks like Mish (Global Economic Trend Analysis) or Pater Tenebrarum (Acting Man) and many others to note that the “money supply” is not just cash, but cash and credit. Remember this, it will come in handy later. First, fiat alchemy …
Inventing Production out of Nothing …
The dream of the lazy (myself included, I must say) has always been to get something for nothing. To eat bread baked by others, made from wheat farmed and milled by others, in exchange for nothing at all. Panhandlers hope to get it through sympathy (I don’t mean that as a slight, mind you, there are many who beg because they cannot work). Slackers in all industries hope to get it by employer indifference (“I used to work hard, but now I just skate by, surfing the web most of the day, and it would be too much trouble for the boss to care enough to fire me”). But for the truly proud, there is only one efficient and acceptable means to this end – creating extra money for themselves to use.
You may have gotten your money by producing wheat or corn and selling it at market, while I may have gotten mine by building widgets. We hardly know at all if someone shows up at the market with a pocket full of money that they printed on a machine in their basement.
Obviously you and I oppose this approach to getting money, for several reasons. First, our sense of justice is violated if we have to work hard for money to buy bread and clothes and movie tickets when others can just turn on a printing press (of sorts). But there is another, less entitled reason. We realize that money is just a mechanism to provide ease of exchange between productive people. If someone shows up with money from nowhere, they will “bid up” prices on all the goods and services in the market, which one might call “price inflation” (not to be confused with inflation of the money supply, though the two are clearly related). The Keynesian may respond “but your production will be ‘bid-up’ too, so you’ll have more money.” True, but not instantaneously. Prices will rise while my wages do not … it’s trickle-down at its worst. Besides, it takes only a grammar school understanding to realize that a 3% inflation of the “money supply” with money-from-nothing will mean that I only get to consume 97% of my production.
Lending Into Existence …
We don’t get monetary inflation these days by printing, as it were. We get it by fractional reserve lending – by lending “money” (or credit, in this case) into existence. You deposit $10,000 at the bank and they promptly lend it out again for someone to purchase something, perhaps office furniture, or a motorcycle, or a new (used) tractor. The person that sold the tractor then re-deposits the $10,000 at the bank, and it is lent out again. Over and over and over the same $10,000 is lent out until various people have $200,000 worth of account balances at the bank … but there was only ever $10,000. The amount of money has inflated.
It’s all a good deal for the bank. On a $10,000 deposit they generated $190,000 of loans at say 3%, which is actually a 57% return given their massive leverage. Of course, they are at great risk. I mean, if all the customers asked for their deposits back we’d have a real mess. (Foreshadowing: not to worry though, there is always another bank that can print its own money and lend it to the bank.)
The Housing Bubble …
This is just how it went down with the housing bubble of the early 2000s, with several wrinkles and complexities. Banks would lend money to homebuyers, secured against the house (asset). They would then sell those mortgages to third parties (a mortgage is, after all, just a “promise to pay” … and secured against an asset at that). Major investment banks would then bundle these mortgages in to “mortgage backed securities” (MBS) in the hopes of selling them to bigger financial players. (Or perhaps keep them on their balance sheet.) Various ratings agencies, which have no interest in being correct in their assessment of risk, would then rate these MBS as good risks so they could be sold on the open market.
Everything chugs along fine as long as prices are going up. But, as we push forward, we find that we’re out of good credit risks and have to lend money to homebuyers with no jobs, no assets (the dreaded NINJA-loan: “no income, no job or assets”). In order to even make their payments they have to take out home equity loans, borrowing from the bank to pay the bank. Eventually it had to come unraveled, and boy did it.
I’m fond of quoting John Stuart Mills on this point: “Panics do not destroy capital; they merely reveal the extent to which it has been previously destroyed by its betrayal into
hopelessly unproductive works.” We spent too much productivity building houses at too great a cost. Eventually this misallocation had to come due. But who will suffer the loss?
Risk No Hurt to the 1% …
When things got really bad in 2008 we realized that these mortgage backed securities were junk. The banks hand lent more into existence than they could possibly hope to get back. It is a problem that has still not been resolved, though we’ve tried many times. The main reason, of course, is that the “wrong people” are going to suffer.
Bankers have a very high notion of themselves. Goldman Sachs chief executive Lloyd Blankfein claims they are all just “bankers doing God’s work” – a point we took up in “Another Piece of Clarity and Almost Courage“. If somebody is going to suffer massive losses for the misallocation of resources during the housing bubble, it dang-well better not be the hyper-rich banking class. Or so Ben Bernanke would have you believe.
A brief glimpse back through the history of the crisis offers some insight. First there was TARP – the Tarnished Asset Revitalization Program. If we leave aside the legal minutiae what we find is “these MBS are worthless, banks are about to suffer HUGE losses, so we have to give them $878 billion.” That didn’t quite do it though. The problem was still there. The MBS products were all-but-worthless. Then came PPIP – the Public Private Investment Program. By some accounts private entities (read investment banks) would put up 7% of the money, the Treasury would put up 93%, and we would buy these MBS to help get the “toxic” assets off the books. Goldman could buy Merrill Lynch and vice versa, and they could all buy or sell to Fannie Mae and Freddie Mack. The entire scheme was just a means to get 93% of the value of this crap pumped into the banks on the public dime. But that, apparently wasn’t enough.
The Federal Reserve owns a “dual mandate” to keep inflation low (but not zero, of course) and maintain full employment in the economy. Here, of course, “full employment” doesn’t mean “everyone employed” – just politically tolerable unemployment levels. This is what the laws say, but that is hardly the way of it.
The thinking at the Fed is dominated by Keynesian economic theories, which have never worked anywhere ever but are loved by throngs of intellectuals who are too clever by half. It is the very definition of a theocracy – empirical data shows Keynesianism to be a failure at every turn and the followers simply respond with “we need to do more!”
Tenebrerum takes up this issue in “The Big Helicopter Money Drop” as he notes in the subtitle “we’ll prove to you that our theories really work.” Bernanke’s QE programs have failed to spur the economy, so he issues QE-infinity, saying “well go on with this as long as we have to until it works.”
But what does he really mean by this. Well, he could just be following traditional Keynesian ideology: if it hasn’t worked yet it’s because we haven’t done enough. But if that were it then why not announce another limited QE, not an infinite QE? No, Bernanke’s meaning is, I think, slightly different on two fronts.
First, he’s finally going to cover the MBS problem. Where TARP and PPIP failed to finish off the bad lending of the housing bubble, QE-infinity will. Bernanke is going to print up $40 billion a month to by MBS (worthless junk) and take them off the books of the 1%. Remember, we cannot allow the pain of bad lending to be passed to the bankers, who were just doing “God’s work” (depending on just who your god is). If the common man is wiped out for years so be it.
But there is another angle to this in the light of money and credit. Attitudes on money and credit have greatly changed, just as they did after the Great Depression. People no longer view living beyond their means as a good way to secure their future. They are less and less willing to borrow money to pay for what they want, and are instead reducing their debts. In the credit-is-money world this is tantamount to deflation – a decrease in the money supply. It is driven by attitudes (and fears).
Ben Bernanke and the Wall Street gang desperately want inflation. In simple terms, it is the mechanism whereby they appropriate for themselves some of your production. When you and I eschew their means of causing inflation (borrowing) they panic. With QE-infinity Bernanke is saying “I will bail out the banks, and I will print forever until you stupid people change your minds and start living carelessly again – borrowing more money than you can hope to pay back, making yourselves debt-slaves, and building up the asset value of the 1%. And, if I might add, how dare you! How dare you refuse to borrow, refuse to give us your life’s production. How dare you! We live by shaving off a fraction of your production – this is our birthright, we are but humble bankers doing god’s work.”
Risk no hurt to the 1%.
Now on to the Future …
If I were to make a prediction, I’d piggyback on something Mish said a while back. He noted that sooner or later one of these QE moves by the Fed was going to blow sky high. Sooner or later, one of these utterly fraudulent, utterly immoral QE policies will tear teh whole thing asunder (my words). My gut feeling is that the time is now. Bernanke has gone all-in for the 1% and there is a real risk (hope?) that the 99% wake up … and wake up pissed.
To this end we’ll offer two scriptures, one which allows us to take heart, and another which gives us clear direction.
“I have seen a wicked and ruthless flourishing like a luxuriant native tree, but he soon passed away and was no more; though I looked for him, he could not be found.” – Psalm 37:35-36
“But to you who are listening I say: Love your enemies, do good to those who hate you, bless those who curse you, pray for those who mistreat you.” – Luke 6:27-28