Submitted by David Stockman via Contra Corner blog,
QE has finally come to an end, but
public comprehension of the immense fraud it embodied has not even
started. In round terms, this
official counterfeiting spree amounted to $3.5 trillion— reflecting
the difference between the Fed’s approximate $900 billion balance sheet
when its “extraordinary policies” incepted at the time of the Lehman
crisis and its $4.4 trillion of footings today. That’s a lot of
something for nothing. It’s a grotesque amount of fraud.
The scam embedded in this
monumental balance sheet expansion involved nothing so arcane as the
circuitous manner by which new central bank reserves supplied to the
banking system impact the private credit creation process. As is now evident, new credits issued by the Fed
can result in the expansion of private credit to the extent
that the money multiplier is operating or simply
generate excess reserves which cycle back to the New York Fed if, as
in the present instance, it is not.
But the fact that the new reserves
generated during QE have cycled back to the Fed does not mitigate the
fraud. The latter consists of the
very act of buying these trillions of treasuries and GSE securities in the
first place with fiat credits manufactured by the central bank. When the
Fed does QE, its open market desk buys treasury notes and, in exchange,
it simply deposits in dealer bank accounts new credits made out of
thin air. As it happened, about $3.5 trillion of such fiat credits were
conjured from nothing during the last 72 months.
All of these bonds had
permitted Washington to command the use of real economic resources. That is, to consume goods and services it obtained
directly in the form of payrolls, contractor services, military tanks
and ammo etc; and, indirectly, in the form of the basket of goods and
services typically acquired by recipients of government transfer
payments. Stated differently, the goods and services purchased via
monetizing $3.5 trillion of government debt embodied a prior act
of production and supply. But the central bank exchanged them for an act of
nothing.
Contrast this
monetization process with honest funding of government debt in
the private market. In the latter event, the
public treasury taps savings from producers and income earners and re-allocates
it to government purchases rather than private investments. This has the
inherent effect of pushing up interest rates and, on the margin, squeezing
out private investment. It is a zero sum game in which savings retained
from existing production are reallocated.
To be sure, the economic effect
is invariably lower investment, productivity and growth down the line, but the
process is at least honest.
When the public debt is financed from savings, government purchase of
goods and services are funded with the fruits of prior production. There
is no exchange of something for nothing; there is no financial fraud.
And it is the fraudulent finance of
public deficits which is the real evil of QE because the ill effects go far beyond the standard saw that
there is nothing wrong with central bank monetization of the public debt unless
is causes visible inflation of consumer prices. In fact, however, it does
cause enormous inflation, but of financial asset values, not the CPI.
Despite the spurious implication to
the contrary, central banks have not repealed the law of supply and demand in
the financial markets.
Accordingly, their massive purchases of the public debt create an artificial
bid and, therefore, false price. Moreover, government debt functions as the
“risk free” benchmark for pricing all other fixed income assets such as home
mortgages, corporate debt and junk bonds; and also numerous classes
of real assets which are typically heavily leveraged such as commercial
real estate and leased aircraft.
In short, massive
monetization of the public debt results in the systematic repression of
the “cap rate” on which the entire financial system functions.
And when the cap rate gets artificially pushed down to sub-economic levels
the result is systematic over-valuation of all financial assets, and the
excessive accumulation of debt to finance non-value added financial engineering
schemes such as stock buybacks and the overwhelming share of M&A
transactions.
Needless to say, the false prices which result from massive
monetization do not stay within the canyons of Wall Street or even the
corporate business sector. In
effect, they ride the Amtrak to Washington where they also deceive
politicians about the true cost of carrying the public debt. At the present
time, the weighted average cost of the $13 trillion in publicly held federal
debt is at least 200 basis points below a market clearing economic
level—–meaning that debt service costs are understated by upwards of $300
billion annually.
At the end of the day, the fraud of
massive monetization makes the rich richer because it drastically inflates the
value of financial assets—–roughly 80% of which is held by the top 5% of
households; and it makes the state more bloated and profligate because its
enables the politicians to spend without imposing the pain of taxation or the
crowding out effects which result from honest borrowing out of society’s
savings pool.
In the more wholesome times before
1914, the Federal government didn’t borrow at all. During the half-century between the battle of Gettysburg
and the eve of World War I, the public debt did not rise in nominal terms, and
amounted to just $1.5 billion or 4% of GDP at the time of the Fed’s creation.
Even then, the Fed was established as only a “bankers bank” which could not own
a dime of public debt, but instead existed for the narrow mission of liquefying
the banking market by means of discounting solid commercial paper on receivables
and inventory for ready cash.
The modern form of monetization
arose in the service of financing war bonds, not managing the business cycle,
levitating the GDP or boosting the labor market toward the artifice of “full
employment”. These latter purposes reflect a
century of “mission creep” and the triumph of the statist assumption that
governments can actually tame the business cycle and elevate the trend rate of
economic growth.
But history refutes that conceit. In the early post-war period, central bank interventions
mainly caused short term bouts of unsustainable credit growth and an
inflationary spiral which eventually had to be cured by monetary stringency and
recession. In the process of repetition over several decades culminating
in the 2008 crisis, the household and business leverage ratios were steadily
ratcheted upwards until the reached peak sustainable debt.
Now the credit channel of monetary
policy transmission is broken and done.
The Fed’s most recent massive monetization and “stimulus” has therefore simply
inflated financial asset values—-meaning that the Fed has become a serial
bubble machine.
There is a better way, and it
contrasts sharply with the systematic fraud of QE. That alternative is called the free market, and at the heart
of the latter is interest rates which are “discovered” by the market, not
pegged and administered by the central bank. Stated differently, the free
market requires that all debt and other forms of investment
be funded out of society’s pool of honest savings—-that is, income
that is retained out of production already made.
Under that regime there is no fraudulent bid for public
debt and other existing assets based on something for nothing. Markets clear where they will, and interest rates are
the mechanism by which the supply of honest savings and the demand
for investment capital, including working capital, are balanced out.
Needless to say, free market
interest rates are the bane of Wall Street speculators and Washington spenders
alike. They can spike to sudden and
dramatic heights when demand for funds to finance government deficits or
financial speculation out-run the voluntary pool of savings generated by
society. So doing, they bring financial bubbles and fiscal profligacy up
short.
In stopping QE after a massive spree
of monetization, the Fed is actually taking a tiny step toward liberating the
interest rate and re-establishing honest finance. But don’t bother to inform our monetary politburo. As soon
as the current massive financial bubble begins to burst, it will doubtless
invent some new excuse to resume central bank balance sheet expansion and
therefore fraudulent finance.
But this time may be different.
Perhaps even the central banks have reached the limits of credibility—- that
is, their own equivalent of peak debt.
“I think QE is quite effective,” Boston Fed President Eric Rosengren said in a recent interview with The
Wall Street Journal, describing the approach as an option for dealing with an
adverse shock to the economy.
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