In trying to explain what the Federal Reserve and Ben Bernanke have been doing to our money I realized that 75% of the citizens of this Republic are uninformed to what Quantitative Easing is, well lets first look at the origins of the words they use to describe their actions. Quantitative: meaning the measuring of an amount, in this case the amount is money. Easing: to move, shift, or be moved or be shifted with great care or in this case to move money into the market with a specific goal.
The goal of this easing or shifting of a measured amount of dollars into the currency pool is to expand economic growth or in the case of our latest "financial crisis" to purchase the toxic Mortgage Backed Securities. The reasons for the toxic assets is a discussion for a later date but in 2008 when the market imploded because of the over-estimated values of these pieces of paper the banks that held them and the investors who owned them realized they were worthless because their collective value was based on the promise of the payer paying his debt. So the Federal Reserve in conjunction with the Treasury Dept. came up with a plan to rescue the economy by purchasing all of these worthless pieces of paper but there was one very significant problem with their plan they had to print the money to buy the assets.
Now why is this a problem?
Quantitative Easing involves the creation of a significant amount of new base money by a central bank for the buying of assets that it usually does not buy. Usually, a central bank will conduct open market operations by buying short-term government bonds or foreign currency. However, during a financial crisis, the central bank may buy other types of financial assets as well. The central bank may buy long-term government bonds, company bonds, asset backed securities, stocks, or even extend commercial loans. The intent is to stimulate the economy by increasing liquidity and promoting bank lending, even when interest rates cannot be pushed any lower.
Quantitative easing increases reserves in the banking system (i.e. deposits of commercial banks at the central bank), giving depository institutions the ability to make new loans. Quantitative easing is usually used when lowering the discount rate is no longer effective because interest rates are already close to or at zero. In such a case, normal monetary policy cannot further lower interest rates, and the economy is in a liquidity trap.
Asset based Currency:
For many years before most of us were born our dollars had a value, they were guaranteed to be worth something because they were backed (pegged) by a "hard asset" first silver and then gold. The US adopted a silver standard based on the Spanish milled dollar in 1785. This was codified in the 1792 Mint and Coinage Act, and by the Federal Government's use of the "Bank of the United States" to hold its reserves, as well as establishing a fixed ratio of gold to the US dollar. This was, in effect, a derivative silver standard, since the bank was not required to keep silver to back all of its currency.This began a long series of attempts for America to create a bi-metallic standard for the US Dollar, which would continue until the 1920s. Gold and silver coins were legal tender, including the Spanish real, a silver coin struck in the Western Hemisphere. Because of the huge debt taken on by the US Federal Government to finance the Revolutionary War, silver coins struck by the government left circulation, and in 1806 President Jefferson suspended the minting of silver coins.The US Treasury was put on a strict hard-money standard, doing business only in gold or silver coin as part of the Independent Treasury Act of 1848, which legally separated the accounts of the Federal Government from the banking system. However the fixed rate of gold to silver overvalued silver in relation to the demand for gold to trade or borrow from England. The drain of gold in favor of silver led to the search for gold, including the California Gold Rush of 1849. Following Gresham's law, silver poured into the US, which traded with other silver nations, and gold moved out. In 1853, the US reduced the silver weight of coins, to keep them in circulation, and in 1857 removed legal tender status from foreign coinage.In 1857 the final crisis of the free banking era of international finance began, as American banks suspended payment in silver, rippling through the very young international financial system of central banks. In 1861 the US government suspended payment in gold and silver, effectively ending the attempts to form a silver standard basis for the dollar.Towards the end of the 19th century, some of the remaining silver standard countries began to peg their silver coin units to the gold standards of the United Kingdom or the USA. For 86 years after this we used silver certificates as the backing asset for our legal tender.Â Silver Certificates are a type of representative money printed from 1878 to 1964 in the United States as part of its circulation of paper currency. They were produced in response to silver agitation by citizens who were angered by the Fourth Coinage Act, which had effectively placed the United States on a gold standard. The certificates were initially redeemable in the same face value of silver dollar coins, and later in raw silver bullion. Since 1968 they have been redeemable only in Federal Reserve Notes and are thus obsolete, but are still valid legal tender.
The whole time during this period and up until August 15, 1971 we used the "gold standard" to set the value of the dollar to other world currencies.
The gold standard is a monetary system in which the standard economic unit of account is a fixed weight of gold. There are distinct kinds of gold standard. First, the gold specie standard is a system in which the monetary unit is associated with circulating gold coins, or with the unit of value defined in terms of one particular circulating gold coin in conjunction with subsidiary coinage made from a lesser valuable metal.
No country currently uses the gold standard as the basis of their monetary system, although several hold substantial gold reserves.
What makes this significant is all countries that used the gold standard were limited to the amount of money they could print to the amount of gold they owned. It limited what the Federal Reserve Bank could do in controlling the national economy and had been falsely blamed for several economic downturns and the "Great Depression", "in my opinion and research falsely".
So in 1971 we started basing the value of our money on the Gross Domestic Product of our country.
Gross domestic product:
(GDP) refers to the market value of all officially recognized final goods and services produced within a country in a given period. It determines the circulation of dollars and helps project the government revenue (taxes) that will be available each year to run the country. But it also lets the federal reserve monitor how money is being used to buy those goods and services and allows them to step in when the reserve liquidity tightens. Without getting too technical reserves are just that like the extra players on sports teams or the extra products you store at home when they run low or run out they need to be refilled, if a player gets hurt while playing another player needs to replace them. Same with the dollars if a bank or lending institution runs low on money part of the federal reserves job is to replace it by sending them dollars. So in 2008 when all of the banks started asking the Federal Reserve for extra dollars to pay for the bad debts they bought, the only way they could do this was to print it.
And there lies part of the reason you are now paying between 30%-100% more for everything in the past 3 years, the dollars being used to buy these assets are not related to the value of the goods and services they represent. The GDP has been stagnant with no real significant growth since 2008 with an annual average of 13 Trillion dollars.
But the amount of money printed and circulated, saved and invested worldwide has grown and it is known as the "monetary supply" of the United States.
The Monetary Supply:
In 2008 the monetary supply which is all the money in our system in every bank, pocket, business etc. where ever there is a dollar it is part of the monetary supply was 8.448 trillion dollars or 64.9% of the GDP. That number includes the original TARP monies of 848 billion injected in the market that year.The current monetary supply as of March 13, 2012 is 9.578 trillion or 73.6% of GDP. And what is worse is their latest round of cash infusion has not only deflated the value of yours and my dollars but raised the costs of everything we buy by not allowing the exchanges to reset themselves to reflect the actual economic climate. Since the start of Quantitative Easing by the Federal Reserve, everything has almost doubled in cost because of the doubling effect of both market and monetary policy manipulation.
So the Federal Reserve has been printing more dollars but the engine to make those dollars worth more is stalled so in car speak the Fed has flooded the engine. They have not only placed more dollars into the economy making the dollars that were already there worth less but by purchasing stocks, bonds and other hard assets and commodities they have raised the cost of everything related to their purchases. Yes you know about QE1 which bought 1.25 trillion dollars of debt, QE2 which purchased 900 billion dollars of long term Treasury notes. But since the end of QE2, QE3 where the Fed has been quietly injecting more money into the stock market to "prop it up" there latest balance sheet from March, 15, 2012 shows the new assets on their books.
And in the 3 plus years of this fiscal policy the effects are hurting everyone.
Gold in 12/2008 = $850.00 per once / 03/20/2012 $1640.00 per ounce
Oil in 12/2008 = $38.00 per barrel / 03/20/2012 %107.00 per barrel
Gas in 12/2008 = $1.05 per gallon futures exchange and $1.72 at the pump nationally / 03/20/2012 $ 3.09 per gallon on the futures exchange $3.89 a gallon at the pump.
Milk in 12/2008 = $2.79 per gallon / 03/20/2012 $3.89 per gallon.
Beef in 12/2008 = $ 2.89 per lb. 80/20 ground chuck / 03/20/2012 $4.59 per lb.
Not all of the current financial hardship's we face are due to Quantitative Easing but it has not been by any means the panacea it was touted to be for the economy and the other shoe is yet to drop. The Federal Reserve currently holds over 2.7 trillion dollars in debt obligations from lenders and banks. That is more than the GDP of 90% of the countries on this planet. When you falsely base the value of anything and then try to sell it, it will only be worth what the buyer is willing to pay for it.Â Now just as I am writing this the Fed just released their 2011 earnings stating they made 77 billion dollars but the data is not yet up on their website. We will wait to analyze the statements.
But their fiscal policy has us on the road that has been well traveled.
This has happened before:
After the end of WW1 the German Republic owed reparations to half of Europe for damages and penalties for their invasions of France, Poland and most of the Western European continent. You see Germany had gone off the gold standard in 1914, and could not effectively return to it as Germany had lost much of its remaining gold reserves in reparations. The German central bank issued un-backed marks virtually without limit to buy foreign currency for further reparations and to support workers during the Occupation of the Ruhr finally leading to hyperinflation in the 1920s.
The growing postwar economic crisis was a result of lost pre-war industrial exports, the loss of supplies in raw materials and foodstuffs from Alsace-Lorraine, Polish districts and the colonies, along with worsening debt balances, but above all, the result of an exorbitant issue of promissory notes raising money to pay for the war. Military-industrial activity had almost ceased, although controlled demobilization kept unemployment at around one million. The fact that the Allies continued to blockade Germany until after the Treaty of Versailles did not help matters, either. The allies permitted only low import levels of goods that most Germans could not afford. In its 14 years, the Weimar Republic was faced with numerous problems, including hyperinflation, political extremists on the left and the right and their paramilitaries, and hostility from the victors of World War I, who tried twice to restructure Germany's reparations payments through the Dawes Plan and the Young Plan. However, it overcame many of the requirements of the Treaty of Versailles(Germany eventually repaid a reduced amount of the reparations required of the treaty with the last payment being made on 3 October 2010).
The 1920s German inflation started when Germany had no goods to trade. The government printed money to deal with the crisis; this meant payments within Germany were made with worthless paper money, and helped formerly great industrialists to pay back their own loans. This also led to pay raises for workers and for businessmen who wanted to profit from it. Circulation of money rocketed, and soon banknotes were being overprinted to a thousand times their nominal value and every town produced its own promissory notes.
The value of the Papiermark had declined from 4.2 per U.S. dollar at the outbreak of World War I to 1 million per dollar by August 1923. This led to further criticism of the Republic. On 15 November 1923, a new currency, the Rentenmark, was introduced at the rate of 1 trillion (1,000,000,000,000) Papiermark for one Rentenmark, an action known as a monetary reset.
We have not yet had to go through that here in this country but it is not far off, under the current economic polices we have been down-graded for the first time in our history and we are facing the possibility that the dollar will stop being used as the "world currency" for trading on the exchanges. One of the benefits of being one of the last countries to come off the gold standard was that the U.S. dollar by default became the preferred currency when commodities such as gold, oil, silver, corn, wheat etc. are traded or sold their value is set in U.S. dollars. If you think it is bad now, what if the world stopped taking our money or stopped lending to us or devaluing our dollar to the levels that we devalued Germany's less than 100 years ago?
The methodology of Quantitative Easing or printing more money when you need it does not fix more than it delays the inevitable and increases the net effect when you add in the additional inflationary factors that it creates by the lessening of the current value of the purchasing power of our dollars. The inflationary costs by making the dollars in your pocket worth less because there are more of them with nothing to make them worth more and the fact that those extra dollars are not purchasing anything but time to delay what should have occurred already and allowed to reform based on real economic metrics.
"Those that fail to learn from history are doomed to repeat it" Lord Campbell
We have to take responsibility for our elected officials fiscal malfeasance and dangerous policy making if we are to recover from what has already been implemented. We must retract the dollar pool, require a full accounting of the Federal Reserve and then make them answerable to Congress. We must demand that laws and policies that have made for a devalued dollar be immediately rescinded and evaluation of a return to a base standard of currency backing be considered. We must demand a balanced budget both in our own homes and in Washington. We must allow market mechanics to dictate the survival of companies, not the political maneuverings of one party to use Federal dollars to purchase union votes.
There is only one thing that is too big to fail and it is this last bastion of freedom on Earth and her name is The United States of America!
But She is disappearing fast!
Dr. Keith C. Westbrook Ph.D.
Comments are closed for this blog post