Thursday, September 23, 2010

Stealth Monetization in the U.S.A.

Insofar as money is concerned, governments and central banks should be kept as far away from one another as a pedophile from Dakota Fanning. If ever the twain should meet, very bad things would happen. This is because of the disparate natures of government, on the one hand, and the central bank, on the other. 
Governments spend money. They spend money on social programs to keep the people docile and happy, wars to keep up the illusion of safety and security, and—almost as an afterthought—infrastructure. Ordinarily, they get the money for all of these things from taxes and other fees that the government collects. 
On the other hand, central banks print money. Most of the world’s economies depend on fiat currency—currency that has value because someone says it has value. The person who says it has value is the central bank. They are the custodians of the currency—they take care that it retains its value. 
Tons of people say that a fiat currency is unstable, and doomed to fail, and that we will all rue the day that we accepted that abomination into our lives!—and blah-blah-blah, rant-rant-rant. 

But in most cases—all cases, actually, regardless of what the tin-foil hat brigade might rant—fiat currency works like a charm. The proof of this is the last 40 years: All of the world’s major currencies have been fiat since at least 1970. The dollar has been fiat since 1973, and by certain definitions, fiat since 1933, or even 1913—and it’s still around. That’s been because of the Federal Reserve (the U.S.’s name for its central bank). 
Central bank independence is key for a successful fiat currency. If the government ever got its hands on the central bank’s printing presses, all hell would break loose. Rather than raise taxes and collect fees—which are politically unpopular—the government could (and would) direct the central bank to print all the money needed to carry out the government’s various programs. 
This is monetization
What would happen once monetization took place is pretty obvious: So much of the currency would be printed by the government that businesses and ordinary people would lose faith in the currency as a stable medium of exchange. Since fiat money depends on people’s faith in it, this would become a self-reinforcing situation: The currency would fall leading to people losing faith in it, leading to the currency falling even more. 
This is the mid-stages of hyperinflation. Eventually, the currency would become worthless, wrecking the economy of the currency. 
It’s happened more times than one would imagine. But the last time it happened in an advanced economy was Germany in 1922, the so-called Weimar episode. Since then—even during total war in WWII—there has not been an incident of hyperinflation in any advanced economy. (Though as I wrote in Was Stagflation in ‘79 Really Hyperinflation?, there have been bouts of high inflation that had all the traits of incipient hyperinflation.) 
A collapse in the currency is why the government and the central bank are kept separate from one another—the fear of monetization, and what could happen, keeps the two apart. 
However, now, in the good ol’ U.S. of A., monetization is taking place—and it is happening right before our eyes, even though no one is realizing it. This monetization is invisible to sophisticated analyses, but obvious to anyone looking at the situation. Like one of those stealth fighter jets that are visible to the naked eye of a goat herder, but invisible to the radar and infrared and other sophisticated equipment of the professional military? Same thing: 
It’s what I call stealth monetization
What happened in the Fall of 2008? Essentially, banks found themselves holding debts that would never be repaid—which meant the banks could never pay back the money that they in turn owed to depositors and other creditors. 
The bad debts the banks owned—the so-called “toxic assets”—were bonds made from the real-estate and commercial real-estate mortgages, as well as other collateralized debt obligations. Since the properties underlying these bonds had fallen in price—because their prices had been a speculative bubble to begin with—the bonds made from these bundles of loans would never be fully paid off. 
In other words, they were bad loans. Therefore, the banks which had made the loans—the banks which owned these toxic assets—would lose so much money that they would go bankrupt. If they did go broke, the U.S. and world economies would take a massive hit. 
So in order to avert this fate, the Federal Reserve bought these toxic assets from the banks—but the Fed didn’t pay the market value for these toxic assets, which were pennies on the dollar: Instead, the Federal Reserve paid full nominal value for the toxic assets—100¢ on the dollar. The banks the Fed bought these toxic assets from became known as the Too Big To Fail banks—for obvious reasons. 
How did the Fed buy these dodgy assets? Simple: In 2008 and ‘09, the Fed “expanded its balance sheet”. That’s fancy-speak for, “The Federal Reserve created about $1.5 trillion out of thin air.” That’s essentially what they did. The Fed just decided, “We’re going to create $1.5 trillion”—and lo and behold, $1.5 trillion came to be. 
What did the Fed do with this $1.5 trillion it conjured out of thin air? Why, it used it to buy up all the toxic assets and other dodgy assets from the TBTF banks. 
What did the TBTF banks do with all this cash? Why, they turned around and bought U.S. Treasury bonds. 
U.S. Treasury bonds are called “assets” by sophisticated finance types—in fact, sophisticated finance types call all bonds “assets”. But they’re really just debt—including Treasuries. U.S. Treasury bonds are certificates of debt that the U.S. Federal government issues, in order to finance its shortfall, the deficit. 
The U.S. Federal government has been running monster deficits for a number of years now—but lately, it’s gotten pretty bad. In 2009 as well as 2010, the Federal government shortfall was over $1.4 trillion. This is roughly 10% of total U.S. gross domestic product—both in 2009 and 2010: A staggering sum of money. And it is likely that for 2011, the deficit will be another $1.5 trillion or so. 
The Federal government has so much outstanding debt that it is unlikely to ever be able to pay it back. 
A lot of people think this. A lot of sensible people think that a day will come when the markets no longer believe in the Federal government’s promise to pay back its debt. A lot of sensible, smart people think that, one day, no one will buy any more Treasuries— 
—yet every week, Treasury bonds get sold with numbing regularity. The U.S. Federal government has never put Treasuries up for auction which did not get bid on. 
Who are the people who buy these Treasury bonds? The primary dealers—that is, the Too Big To Fail banks. 
In other words, the TBTF banks are financing the Federal government’s massive deficits. How are they doing it? With money the Federal Reserve gave them for their toxic assets. 
This is one leg of stealth monetization
Buying up toxic assets following the 2008 Global Financial Crisis was not the only way that the Federal Reserve got money into the hands of the TBTF banks, and thereby the Federal government—the other thing the Fed did was open up “liquidity windows”. 
Liquidity windows are simply the mechanism by which the Federal Reserve lends money to the banks. The interest rate the Fed assigns to this money it lends to banks is called the Fed discount rate. 
Right now—and for the past several months—the Fed discount rate has been 0.25%. That’s right: One quarter of one per cent. The interest is substantially lower than the inflation rate. This means that the Fed has essentially been giving away free money to the banks. 
What are the Too Big To Fail banks doing with this free money? Why, they are buying Treasury bonds: The TBTF banks are borrowing money from the Fed at absurdly low rates, and then turning around and lending it to the Federal government by way of Treasury bond purchases. 
This is the other leg of stealth monetization
In these two ways, the Federal Reserve has been monetizing the Federal government’s debt. The Fed bought up toxic assets from the TBTF banks, which then went and bought Treasuries. And the Fed is lending money for free to the TBTF banks, which are then buying Treasuries. 
Take a step back, and you get the picture: The Too Big To Fail banks are the sewer system by which the Federal Reserve supplies money to the Federal government for all its deficit spending. 
This is stealth monetization
It’s not even particularly stealthy, actually—it’s happening right out in the open. It’s just that nobody is pointing it out—or perhaps because it is an obscure, complicated system, nobody has realized what it actually is. 
But it’s monetization, pure and simple. The Fed is printing up all the money the Federal government wants and needs. 
To put it more bluntly—and disturbingly—the pedophile is in the room with Dakota Fanning. 
One of the pernicious effects of this stealth monetization is the dis-incentive it gives banks to lend money to small- and medium-sized businesses. Everyone—including the Fed—is complaining that the banks aren’t lending to businesses. But I don’t know why they’re complaining—it makes perfect sense. 
See, the TBTF banks get money for free from the Fed, and then they turn around and lend it to the Federal government by way of buying Treasury bonds. Treasury bonds are paying absurdly low yields, because they’ve been bid up so high by all those freshly minted dollars that the Fed printed up. But to the TBTF banks, it doesn’t matter how low the Treasury yields are—it’s still guaranteed profits. Lending money to the Federal government is totally safe. 
But a loan to a small- or medium-sized business? It’s a risk—and a risk for only a slightly higher profit. The business might miss a payment, or even go broke. Plus it’s a hassle, to lend to a busines—all that administrivia! The paperwork, the loan applications, the due dilligence—blah-blah-blah-blah! 
“Screw it,” say the TBTF banks. “Let’s just buy Treasuries.” 
That’s how the American government’s massive deficit is sucking up all the available funds. Why bother lending to the private sector, when the Federal government is paying good interest on the Treasury bonds, and the Fed is lending an endless supply of money for free? 
This is why private-sector businesses are not getting any loans, no matter how long the Fed keeps interest rates at rock-bottom levels—the Federal government is hoovering up all that money, leaving the private sector with nothing, not even lint. 
Ben Bernanke and the Lollipop Gang at the Fed do not seem to understand the disincentive they have created—in fact, they just keep on adding even more liquidity: Backstop Benny has announced that QE2 is on the way—that is, further “expansion of the balance sheet”, so as to create more money to give out to more banks— 
—so they can buy more Treasuries from the Federal government. 
Other banks which are not TBTF are getting squeezed—everyone acknowledges that the banking industry is really hurting. But the TBTF banks are racking up monster profits, with monster bonuses. 
That’s because they’re monsters—or more precisely, they are zombies: The American Zombie banks. 
Now this is all good and fine, but is there a simple way to verify that this stealth monetization is indeed what is going on? 
Yes—look at the markets: 
Over the past few months, we have seen two things occurring simultaneously: Treasury bond prices are rising (and therefore their yields are declining), and the dollar has been falling against all commodities and all other major currencies. 
This is a contradiction. This cannot be happening simultaneously for any sustained length of time—unless there is some exterior factor making this contradictory situation happen. 
It is a contradiction because, if over a sustained period of time the dollar is losing value against commodities and other major currencies, then it would not make sense for investors to be putting more money into Treasuries and bidding up their prices. Not when their yields are at such absurdly low levels. 
Stealth monetization: That’s what’s bidding up Treasuries, even as the markets are losing faith in the dollar. 
Poor Dakota Fanning: She’s in the pedophile’s sights—he’s licking his lips as he stares at her—and she has no idea what’s about to happen. 
If you find that imagery seriously disturbing—good: Because then you understand how seriously disturbing stealth monetization really is.
Note: This is an updated version of my original piece, correcting a minor brain fart of mine that was helpfully pointed out to me by readers at Zero Hedge. 


  1. Gonzalo -

    You're right about the end game, but I think you're underestimating how much longer this nonsense can continue. The stock bubble continued to expand several years after the "irrational exhuberance" thing. Housing bubble talk began long before 2006.

    U.S. Treasury Bond Bubble talk is just getting started (in the mainstream media that is). Just like the "new economy" talk of the late 1990's allowed stocks to defy gravity for several years, we need to see a parallel to conventional wisdom for Bonds. I think things need to get a lot weirder. Rest assured the "experts" will have explanations ready that convince a lot of people to forget about common sense. That will happen when t-bill yelds go negative. Expect a lot of talk about how "special" U.S. debt is.

    There's much more at stake in this bubble than the housing and stock bubbles combined. Interested parties won't go quietly into the night. I personally think it will take about 5 more years for this bubble to finally pop.

  2. The Fed is trying to monetize, but unfortunately failing to do so. The notional money they are creating and handing out for free to the TBTF banks is mainly going into keeping the stock market artificially inflated and as you mention, buying USTs. There is no real "cash" being printed here, and certainly none making it out into the Main Street economy.

    Eventually, the Stock Market will crash, as will the value of USTs, so all the money recently "created" will just as quickly disappear off the face of the Earth, in the Greatest Bonfire of Paper Wealth in All of Recorded History.

    You don't get your hyperinflation until you get the Free Money into the hands of the people. As long as the people are starved for Cash (which they are with increasing unemployment), there is no money inthe Main Street economy to drive a hyperinflationary event.


  3. Well, it looks like the first part of your treasury bond prediction may already be coming true.

  4. The underlying cause of this process is the falsification of resources spent. It is also rooted deeply in circular debt purchasing. All explained here:

  5. Is there possibly a third leg to this? Some time back, I remember reading an article on Chris Martenson's blog. I don't recall the details, but the essence of it was that the Fed was printing Dollars, which is would place in foreign bank accounts under the control of foreign central banks. Those central banks would then buy UST's. It had the appearance of foreign interest in US Treasuries, but in reality, the Fed was supplying the funds, just at they are today with the TFTF banks. Either way, they are monetizing the debt!

  6. the Federal Reserve paid full nominal value for the toxic assets—100¢ on the dollar.

    FOA, 2001:
    "My friend, debt is the very essence of fiat. As debt defaults, fiat is destroyed. This is where all these deflationists get their direction. Not seeing that hyperinflation is the process of saving debt at all costs, even buying it outright for cash. Deflation is impossible in today's dollar terms because policy will allow the printing of cash, if necessary, to cover every last bit of debt and dumping it on your front lawn! Worthless dollars, of course, but no deflation in dollar terms!"

  7. "Most of the world’s economies depend on fiat currency—currency that has value because someone says it has value. The person who says it has value is the central bank."

    No, that is just an intermediate layer. What fundamentally gives it value is its acceptability for paying taxes.

    "But the last time it happened in an advanced economy was Germany in 1922, the so-called Weimar episode. Since then—even during total war in WWII—there has not been an incident of hyperinflation in any advanced economy."

    What, you don't consider post-war Hungary an advanced economy? It had been integrated into Central Europe, and wasn't that much damaged directly by the war.

  8. Once again, Gonzalo, this is an excellent piece.

    The $USD has been fiat since 1971 (not 1973), or in a sense 1913, as you stated. Those extra 2 years are critical though. Historically, paper money lasts (at most) 40 years before it returns to its intrinsic value (0). This has happened to 100% of paper currencies throughout history, over 3500 of them.

    It will be miraculous to see the $USD go beyond August 15th 2011 without crashing and burning. It is, however, possible for the alchemists (pedophiles in your example) to con the general public through propaganda (the generally government controlled media) and falsified reporting by the BLS and other agencies. It is however imminent that market forces will take hold, forcing a massive selloff of the UST bills/bonds, and then the game is over.

  9. Good grief, Gonzalo. The commodity markets are going ballistic! I will email to you a chart for the NYBOT commodity index. It is the best one because it includes a broad group of commodities traded on the International Commodity Exchange (ICE) through their NYBOT electronic trading platform. The Fed is monetizing the debt! After declaring early this week that inflation isn't HIGH enough, the commodity markets are beginning to comply with the Fed's inflation fantasy!

  10. Great article, keep it up. You explain in simple terms

  11. Reverse Engineer wrote:

    "You don't get your hyperinflation until you get the Free Money into the hands of the people"

    You clearly have no idea what hyperinflation is or how it comes about.

    And as for Bonds and when that epic bubble will come undone, suffice it to say that in five years the bubble will be a distant memory. Among the numerous things that could put a fork in it are the nascent dollar decline to get disorderly. I give that a one in three chance.

  12. Great article.

    However, it seems you presume the gov will print money to, as you put it, get money into the hands of the people.

    Isn't that what the gov is doing NOW?!

  13. Another great piece of explanatory writing - thanks for helping me to understand these issues.

  14. Yes, this contradiction between gold and bonds.

    I think it's because of a time frame difference, partly, and blind ignorance, partly.

    The time frame difference is that people know eventually the dollar is going to hell and so they are getting gold. In the meantime, the fed has given everyone a put on treasuries, and so they think they can be safe in buying them. FOR THE MEANTIIME.

    Also, you just can't help but think that the masses of people are simply living in willful ignorance of how the gubbermint is going to go up, or down, in flames.

  15. Some of the article goes against what I've been seeing at the markets.

    Namely, that banks have been purchasing treasuries, "recycling", the money they received from the Fed for the toxic assets.

    The reason I doubt that is 100% correct is because of the explosion in excess reserves held by the commercial banks at the Fed (

    The excess reserves went ( from 1647 million in January 2008 to 1019586 million in August 2010 (an increase of 1.017 trillion), the last monthly figure reported.

    That would suggest the money the banks reserved for their toxic assets went directly back to the fed.

    That would suggest Fed has been, itself, monetising the treasuries via misnaming the purchases on their balance sheet (as household making these purchases or something to that effect), as suggested by some analysts.

  16. Inflation happens when people bid up the price of goods in money. Hyperinflation happens when people bid up the price of good money.

  17. druid wrote:

    "Hyperinflation happens when people bid up the price of good money."

    That's an effect of hyperinflation, not a cause.

  18. Edwardo said,

    "That's an effect of hyperinflation, not a cause."

    Cause becomes effect becomes cause becomes effect becomes cause becomes effect, ad nauseum.
    You could substitute "result" or "outcome" also.

  19. @Edwardo

    I lived through hyperinflation in Brasil back in the 60s. It happens when Da Goobermint starts passing out free money to keep internal biznesses floating a while longer, while FX is not being earned in sufficient quantity through the trading conduit. This was the dynamic in Weimar and Zimbabwe as well.

    The FSofA is currently in the situation of not earning enough real income to support the currency, however as of yet Da Goobermint is NOT passing out free money to anyone but the TBTF banks. They are losing that money as fast as it gets printed. In the Main Street economy, you have a progressive starvation of Dollars going on. You cannot have people pushing Wheelbarrows full of Dollars when they HAVE no dollars. A distribution method of the Funny Money to the popultion at large must be created to have a true hyperinflationary event.


  20. Does anyone know what is happening or will happen to the "assets" the Fed bought from the banks? EM

  21. I fullly agree with the term stealth monetization. This situation is so mad that one could even go a step further and argue the case that direct monetization bears less cost for the tay payer.

    Since the banks are borrowing at .25% from the Fed (i.e. American People, i.e. tax payer) and are purchasing UST-bonds from the Treasury (i.e. American People, i.e. tay payer) at between 2 and 4%, why not cut out the banks. At $ 1 trillion Treasury debt issuance and an assumed margin of 3%, the tay payer would save $ 30 billion in margin presently going directly to the banks.

    It is the same as doing direct monetization between the Fed and Treasury and simultaneously sending out armoured trucks to the banks handing out as a gift from the US tay payer USD 2.5 billion per month.

    On top, one could argue that this unearned and undeserved windfall, instead of being used to recapitalize banks, goes directly into paying fat bonuses.

    Of course you could say that the banks are holding treasuries with maturities up to 30 years, thus being exposed to interest rate risk.

    But guess what, if there would be a sudden burst of inflation with the necessity to mark-to-market such treasury holdings, the banks would immediately turn to the government and ask for a bail out, this time blaming the government for the situation nobody could have foreseen or for causing the inflation.

  22. Great article explaining what is being done to us. I've had the feeling that something was going horribly wrong (especially my position in TBT) and I think you nailed it.

    My only quibbles are toleration of the Fed's existence and saying fiat "works like a charm". A dollar in 1973 is worth only 21 cents now (courtesy of the Inflation Calculator). Some charm. Other than that, great read.

  23. I think instead of debating whether or not mr Lira's statements and reasonings are true, one should focus on what the scenario would be should they come true. Especially the question of whether there is a likelihood of that bubble bursting and within what any time frame, which obviously is the million dollar question, but hence it is also more interesting. Personally, I think that the risk is here that either this goes on smoothly, in which case we are looking at a long time horizon. Or more likely, there will be certain issues rising in the markets dramatical enough to spur and lift these issues to the surface. In which case, we all would know how to make a buck. Sorry for lack of specific info.

  24. Over these past few days, I have thought again and again about the title of this article. It is one of those so succinctly correct that it manages to concisely encapsulate precisely what is going on.

    Rick Santelli said it tersely on the floor of the CME -- QE IS monetizing the debt! He said it is impossible to have QE without monetizing the debt! But it is a devious and underhanded method -- a stealth monetization! And it also says something fundamental about the nature of the people who carry it out in a stealthy and devious way. It tells us that THEY are devious, scheming, dishonest! Can we then trust them in ANYTHING? I think not!

    Is it any wonder, then, that the USD is in another fall from the cliff and that gold hit another new high of $1314.80 (futures) overnight?

    Thanks for finding a way to express this reality in such stark and poignant terms!

    I'm beginning to wish I lived in Chile!

  25. P.S. And the image of the dollar toilet paper roll is a picture worth a thousand words! I copied it to my hard drive for some future use that I haven't even imagined yet!

  26. @Andreas

    The idea of the gov't just giving out the money directly to the people has been out there is mass email campaigns I've seen. Only there would have to be stipulations, or that would cause massive inflation. For example, the money could only be used for paying off personal debts or mortgages, or buying real estate, home improvements, energy efficient furnaces/appliances. Just a thought, I'm not well-versed like many here seem to be. I'd be interested in feedback.

  27. @imark

    Targeting giveaways toward certain items would cause inflation in those items. Here is my true story. In the last two years, I had my roof replaced and installed double-paned windows. Gov't incentives for energy savings exist for both those types of improvements. However, BOTH contractors said (to their own detriment) that the cost of using the replacements that qualified for the gov't incentives was way more than the incentives and the savings involved. In other words, the existence of the incentives drove the cost of both the shingles and the windows to the point where it didn't make economic sense to buy them.

    My point: Government giveaways distort prices and encourage people to produce othern than what people want.

  28. poor smart bastardOctober 18, 2010 at 2:16 AM

    hi, a quick thought to those of you repeatedly stating that the money needs to be distributed to the people at large, and not the banks, for inflation to occur.

    It seems clear to me that the money is clearly reaching the hands of citizens: through the goods and services provided by the state. these 10% of gdp's worth of extra goods and services are funded by deficits, funded by treasuries, funded by banks, funded by fed.


  29. One thing I'm not following. The 0.25% interest rate is for short term loans. If the banks are taking out short term loans, buying government bonds... those loans still must be getting repaid. How is that happening? That doesn't seem to be accounted for in your explanation.


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