Monday, October 31, 2011

Sunday, October 23, 2011

The hidden Obama inflation tax

It has been suggested in some quarters that The Tea Party Movement and their Republican allies have nothing to complain about because neither the Obama administration, nor Nancy Pelosi in her heyday of 2009-2010, raised tax rates. In fact, it is claimed through credits that the Democrats in Congress actually lowered taxes "for 95% of the population!"

Leaving aside the absurdity of cutting income taxes for that 47 percent of the population who pay no income taxes, this utterly ignores the hidden tax of inflation that is simmering away. The Fed has printed more money to pay for Barry and Nancy and Harry's "stimulus". This means more money is going after the same goods and services in our economy. This means the money you or I hold is worth *that much less*. In effect, our money *was* taxed away by Barry and Harry and Nancy, through the mechanism of currency devaluation and corresponding price inflation. You may have noticed prices creeping up in the stores already.

When Pelosi's Congress spent more money than they collected in taxes, and with nearly a *trillion* dollars of "stimulus" they certainly did that, they authorized the Treasury Department to borrow from the public by selling Treasury bills, bonds, and notes. The Treasury offers these securities for sale at public auction, and they are bid for and purchased by banks, pension funds, trusts, corporations, individuals, and above all foreign interests. These are widely considered to be the safest IOUs around. After all, they are guaranteed by the U.S. government.

Inasmuch as Treasury securities are offered at auction, there is no chance they will not be purchased. The Treasury can offer as high a rate of interest as is necessary to attract buyers. Thus, investors, including individuals, pension funds, banks, and life insurance companies needing safety of principal are induced to sell other private debt securities such as bonds, savings accounts, and certificates of deposit, and buy the government IOUs.

Sale of government securities thus absorbs the savings of individuals and corporations. The more that government borrows, the less money that is left over for other borrowers. As a consequence, other borrowers must offer higher and higher rates of interest in order to attract funds. Thus, when the federal government runs deficits, it tends to raise interest rates, and this in turn causes the cost of doing business to rise. As a result, business activity slows down, and both businesses and consumers curtail spending and the economy moves toward recession. Which also explains why Pelosi's and Reid's and Obama's "stimulus" was utterly ineffective.

However, all of the last paragraph assumes a money supply that is kept the same. Enter the "quantitative easing" (printing more money) of Ben Bernacke and the Federal Reserve.

It is widely believed that the Fed is sympathetic with the problems recessions create for politicians, and lowers interest rates in order to keep those politicians in favor with the public. That is not the case at all. The Fed is not a federal agency. It is owned and run by the banking industry. In fact, it is relatively insulated from political pressure, Democrat or Republican, but it has other reasons to act.

What are they? A recession means bad times for the banks. People stop borrowing, corporations lose business, and bank profits drop. When borrowers get into trouble, banks get into trouble. If the recession turns into a full-scale depression, widespread bank failures may result, as they did in the 1920s. Since the Fed is an organization made up of banks, it is clearly in the best interests of those running it to ward off the recession by lowering interest rates. And it does so by expanding the money supply.

When the Fed determines that interest rates should be lowered, or at least prevented from rising any further, it contacts private dealers who make the market in (i.e., who buy and sell) U.S. government securities. The Federal Open Market Committee of the Federal Reserve meets and issues orders to purchase Treasury securities. (Remember, these are the same T-bills and bonds that created the rising interest rates in the first place by absorbing the savings of individuals and corporations.)

The Fed pays the dealers for the securities with Federal Reserve checks, which the dealers then deposit in their banks. The bond dealers' banks then forward those checks to the Fed (where the banks have their reserves on deposit), and the Fed credits the reserve accounts of the banks.

Now the bank has new reserves against which it can make loans. These fresh reserves are just like new deposits from customers, and can be expanded by the same process that all bank deposits are expanded. Under reserve requirements in effect at any point in time (the Fed can change them at will), these reserves can be expanded by five, six, or seven times through what is calls "fractional reserve banking." Thus, when the Federal Reserve buys $1 billion in U.S. Treasury securities, the banks can loan out $5, $6, or $7 billion to borrowers.

Where did the Fed get the money to buy the Treasury securities? It created it out of thin air. It credits the reserve account of a bank by a simple bookkeeping entry. What does the Fed have to back up its IOUs? It has the IOUs of the U.S. Treasury, that is, the Treasury's bills and bonds.

The Federal Reserve accounts thus balance: They show a liability of the bank reserves and the offsetting asset of Treasury securities. The Federal Reserve Notes in your pocket or checking account mean that the Fed owes you money, and these are in turn backed up by the T-bills they hold - which means that the government owes the Fed money. The U.S. government continues to issue more and more IOUs to cover its ever-growing deficits, and the Fed continues to buy these up and issue its own notes in their place.

This whole process is known as "monetizing" debt, which means that the debt of the federal government is turned into money. The government borrows money to meet its deficits, and the IOUs it issues eventually are converted into Federal Reserve Notes. Those greenbacks in your wallet that you think of as money are only government IOUs broken up and reissued by the Fed. And as a result of what the Fed did, your hard earned money is worth that much less...

Thus, in the long run, there is no difference between Nancy and Harry and Barry and the other liberals in the government fighting a recession by taxing money from you and giving it to "green jobs" or "the needy", and the Fed doing much the same by buying up Nancy and Harry and Barry's Treasury bills and giving the banks new reserves. The only difference is in the timing. The effects of government borrowing are almost instantly offset by the effects of government spending. But when the Fed monetizes the government debt, it takes months, or even years, for people to offset the influx of new money by raising their prices. The Fed action just postpones the inevitable a bit longer than the government action does.

Federal deficits, then, are the primary cause of continued inflation of the money supply. Once banks have loaned out their depositors' money to the maximum limit set by reserve requirements, the only source of new dollars is the Federal Reserve.

Sunday, October 09, 2011

Dirty Laundry

Saw a link to this T-shirt at cafepress earlier. I think it's a pretty good response to those whose T-shirts express the idea that "Our totalitarians are cool."

The text reads “My Che and Mao t-shirts are in the wash”. Not bad. And, the back depicts the numbers of people killed by the Soviets and the Maoists next to the number killed by the Nazis (hint: each of the former racked up a higher body count), with a general admonition against totalitarianism.