Monday, September 7, 2009

More Monetary Lunacy

So, I just saw the advertisement for Michael Moore's 'Capitalism'. Of course, one does not expect a lot of Moore, he being incapable of correctly diagnosing any sort of problem. However, he seems to manage to grasp the obvious fact that there is some sort of a problem.

I could go through his faults over and over, starting with his failed analysis of Columbine, through his misunderstanding of climatology, including his incapability to understand the politics of health care, up to now, his new missive missing the point on economics. To be perfectly fair, I have not seen any of his movies and won't start with this one; all my analysis is hearsay, but that really doesn't matter, because plenty of people hold the idea I wish to deal with now.

Moore stands in front of Wall Street and yells, "We want our money back!"

I think, more than anything, this piece of transparent grandstanding shows the central misunderstanding: that the money ever existed and that it ever was 'ours'. For the first part, the truth is that much of the 'money' used in this boom never existed, and the bailout money is all fake anyway.

Let me explain. First of all, lots of the collateralized debt, debt turned into an asset and loaned against, created money that didn't exist prior to the collateralization. In other words, the bank owns mortgages, for instance, which it terms assets, against which it must maintain a certain minimum reserve. However, if the bank packages these debts into a collateralized debt obligations, acronym CDO, then they can be sold as bonds, which the buyer can consider an asset. If the buyer is a bank, they can loan against that asset. If the buyer is someone else, a real estate developer, for instance, they can borrow against that asset. The great genius was the creation of a new way to do fractional reserve banking. They, of course, went on to create a massive derivatives market as well, but that's another story. Suffice to say, most of the money lost so far never really existed in the way we think of money normally, which is to say consideration for services rendered, or, in the vernacular, 'pay'.

The money was created out of thin air, in other words, and back to thin air it went. This, to put it simply, would be fraud in another age. In our age, the best and brightest went to Wall Street and created this mess, being called miracle workers and the drivers of the new prosperity. These same people are being asked to fix the problem now, and their prescription is exactly more of the same, as it is the only thing they know how to do.

This brings us to the second part. The money used for the bailout is also imaginary and never was ours. Basically, if you look at the US dollar, it says 'Federal Reserve Note'. The money is emitted by the Federal Reserve Bank of the United States of America, or FRBOTUSA using the classic American acronym tradition. This money does not come from the United States government. It comes from an independent organization that is theoretically controlled by the government only in that the president appoints the chairman. Treasury notes used to be common but are all but unknown now. The treasury does countersign all FRN, but it's not the same thing as emitting them.

Why does this matter? Well, when the government runs a 50% deficit, as it appears it will this year, all that money has to come from somewhere. The mechanism, near as I can tell, is that the treasury issues notes, which are bills or bonds, which go to the reserve bank, where they are partially auctioned to foreign investors and partially bought by the reserve bank itself. The reserve bank, using its plenary powers, simply prints, er, creates electronically, enough money to cover the purchase. This is important, because the fed now thinks it has 'assets', which are those bonds and bills.

Most of the 'open market operations' the fed engages in involve those bonds and bills. It swaps them with other banks 1:1 face value. In this way, banks get to unload questionable loans onto the fed, and get US Bonds and TBills in return. This does two things. Obviously, it removes toxic debt from the banks' sheets, which improves its bottom line as these debts will be repaid. Less obviously, it changes a large amount of debt from sub prime to triple-a. This means the bank's reserve ratio gets lower and they can loan more money, in theory.

The 'bailout' that was financed by congress, however, is slightly different. The money to make those payments, of course, did not come in from tax revenue; the money came from debt, which, as stated above, is at least partially produced by the fed. Here's the fun part: that money never needs to be repaid because it is 'owned' by the fed. At least, the part the fed owns does not need to be repaid. When it is swapped to a bank, the fed, first of all, will have to print up money to cover the bad debt it swapped for, and second, the banks will expect repayment, which I'm sure the fed will be happy to provide.

In other words, the US government will have to 'repay' the bonds and other debt instruments, but it will do so by borrowing more money. The genius of the scheme is that the banks get paid 'real money' in return for their bonds that they swapped bad debt for, and now they can swap more bad debt for bonds that were issued to repay the banks. It's all not really 'fraud' because it is legal.

The Federal Reserve Bank of the United States and the United States Treasury Department would like to remind you that they are pretty certain they are working in your best interest, or at least that's what all their banker friends are telling them.

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