Currency Wars_ The Making of the Next Global Crisis - James Rickards [92]
This bond scam was shot down on Capitol Hill, and once it failed, the Fed needed another solution quickly. It was running out of time before QE would need to be reversed. The solution was a deal arrived at between the Treasury and the Fed that did not require approval from Congress.
The Fed earns huge profits every year on the interest received on Treasury bonds the Fed owns. The Fed customarily pays these profits back to the Treasury. In 2010, the Fed and Treasury agreed that the Fed could suspend the repayments indefinitely. The Fed keeps the cash and the amount the Fed would normally pay to the Treasury is set up as a liability account—basically an IOU. This is unprecedented and is a sign of just how desperate the situation has become.
Now as losses on future bond sales arise, the Fed does not reduce capital, as would normally occur. Instead the Fed increases the amount of the IOU to the Treasury. In effect, the Fed is issuing private IOUs to the Treasury and using the cash to avoid appearing insolvent. As long as the Fed can keep issuing these IOUs, its capital will not be wiped out by losses on its bond positions. On paper the Fed’s capital problem is solved, but in reality the Fed is increasing its leverage and parking its losses at the Treasury. Corporate executives who played these kinds of accounting games would be sent to jail. It should not escape notice that the Treasury is a public institution while the Fed is a private institution owned by banks, so this accounting sham is another example of depriving the taxpayers of funds for the benefit of the banks.
The United States now has a system in which the Treasury runs nonsustainable deficits and sells bonds to keep from going broke. The Fed prints money to buy those bonds and incurs losses by owning them. Then the Treasury takes IOUs back from the Fed to keep the Fed from going broke. It is quite the high-wire act, and amazing to behold. The Treasury and the Fed resemble two drunks leaning on each other so neither one falls down. Today, with its 50-to-1 leverage and investment in volatile intermediate-term securities, the Fed looks more like a poorly run hedge fund than a central bank.
Ed Koch, the popular mayor of New York in the 1980s, was famous for walking around the city and asking passersby, in his distinctive New York accent, “How’m I doin’?” as a way to get feedback on his administration. If the Fed were to ask, “How’m I doin’?” the answer would be that since its formation in 1913 it has failed to maintain price stability, failed as a lender of last resort, failed to maintain full employment, failed as a bank regulator and failed to preserve the integrity of its balance sheet. The Fed’s one notable success has been that, under its custody, the Treasury’s gold hoard has increased in value from about $11 billion at the time of the Nixon Shock in 1971 to over $400 billion today. Of course, this increase in the value of gold is just the flip side of the Fed’s demolition of the dollar. On the whole, it is difficult to think of another government agency that has failed more consistently on more of its key missions than the Fed.
Monetarism
Monetarism is an economic theory most closely associated with Milton Friedman, winner of the Nobel Prize in economics in 1976. Its basic tenet is that changes in the money supply are the most important cause of changes in GDP. These GDP changes, when measured in dollars, can be broken into two components: a “real” component, which produces actual gains, and an “inflationary” component, which is illusory. The real plus the inflationary equals the nominal increase, measured in total dollars.
Friedman’s contribution was to