Dear Diary,

Yes, we were in London, taking care of business. Now, we’re back in Buenos Aires.

We’ve tried medication. We’ve tried prayer. We’ve tried heavy drinking – all in an effort to understand how our crazy money system works. And where it leads.

You’d think it would be easy. It’s just Central Banking 101, no?

Well, no. It is squirrelly… and diabolically subtle. We doubt anyone understands it – especially those who are supposed to control it.

The basic unit for the system is a kind of money the world has never had before: the post-1971 fiat dollar.

It’s paper money – worth as much as people think it is worth… and managed by people who think it should be worth less as time goes by.

What a Business!

Who are these people? Who do they work for?

You might say they are “public servants.” But that implies they are working on the public’s behalf.

Nooooo sireee…

They are employees of a banking cartel that is owned by private banks. These banks have a license to lend money into existence, earning interest on their loans.

It is no surprise that their share of US corporate profits has risen fourfold since President Nixon ended the quasi-gold standard Bretton Woods system.

What a business! Their cost of goods sold is next to nothing. A few strokes on a keyboard and millions… billions… heck, trillions… of dollars are created.

As our friend and economist Richard Duncan points out in his book The New Depression, the amount of liquid reserves banks have to hold against their loans is now so small they provide “next to no constraint” on the amount of credit the system can create.

Banks just have to maintain a certain “capital adequacy ratio.” This restricts their lending to a multiple of their equity capital (money provided by their shareholders).

Of course, money is valuable only as long as there is not too much of it. The market can absorb a little counterfeited money. But there’s a limit.

And that limit has been greatly increased, thanks to:

1) A worldwide overcapacity of output, financed by previous lending

2) A huge glut of cheap labor, also largely brought forth by the credit expansion of the last 30 years

Without these unique circumstances, central banks’ irresponsible policies – ZIRP and QE – would probably have caused inflation to rise to the double-digit range already… maybe higher.

Free Money for Governments

The authorities must feel like a college student who has found his professor’s exam questions. He knows he’s going to get away with something…

And since there are about 1 billion people who live on $1 or less per day, central bankers expect to get away with a lot more. Not only that, but also they’re lauded as heroes for it.

And now there’s no further need to worry about how much governments borrow. Central banks buy governments’ bonds… hold them on their balance sheets… return the interest payments… and the whole thing will be forgotten.

And when those bonds expire, central banks can use the repaid principal to buy more government debt!

In effect, today’s raft of central bankers is doing something previous central bankers could only dream of doing: printing money without causing inflation.

Politicians, too, are enjoying this once-in-a-lifetime opportunity for recklessness. They will be able to do what none could do before: borrow money without paying it back.

We have not seen it in the press yet, but it should be coming soon. Commentators and kibitzers are bound to urge Germany to lighten up:

“Why should Greece have to repay those loans, anyway? Where did the money come from? It didn’t come from German taxpayers. It came from nowhere, like all the rest of the world’s money. And so what if it isn’t repaid? What difference will it make? None.”

Nirvana for Public Finance

Duncan, whose analysis of liquidity levels at Macro Watch helps us understand the effects of QE, believes central banks should – and will – buy 100% of government bond issuance… and then simply set fire to them.

Too much government debt? Problem solved…

Hallelujah! Hallelujah! Nirvana for public finance has arrived. Heaven has come for politicians. Who says there is no such thing as a free lunch?

We doubt that either the public or Congress has fully come to terms with this. We’ve just realized it ourselves. But eventually they’ll start lining up.

Budget restraint will be yesterday’s worry. Government debt will be written off and forgotten. The feds will be eating breakfast, lunch and dinner on money that never existed… and never will be paid back.

But wait? Is that too good to be true?

Yep. Of course.



Market Insight:
How the Fed Disappears the Debt

by Chris Hunter, Editor-in-Chief, Bonner & Partners

Diary readers are bemused and bewildered by how QE disappears government debt.

And we’ve had a flurry of emails asking us to further explain what’s going on. (To share your thoughts with Bill and me, simply hit “reply” to this email.)

For example, Diary reader Jim S. writes:

So let me see if I understand this! First the feds removed any real-money restrictions on their spending by voiding the convertibility of dollars to gold AND now they have removed any free market restrictions on spending (and selling debt) through an insidious process of selling their debt to themselves.

They have shifted the paradigm without telling anyone. I guess their message is: If you can’t figure out for yourself that’s too bad?

Figuring this stuff out isn’t easy… But it’s important we don’t use complexity as an excuse for ignorance.

Central banks are the 800-pound gorilla in the room right now. If we don’t understand how they work, we don’t understand how the biggest single actor in the economy works. And that’s dangerous.

As the chart below from the Fed reveals, America’s central bank has handed back to the Treasury $500 billion worth of interest payments since it started its first QE program at the end of 2008.


And last year, it handed back $99 billion to the Treasury – or about 20% of the government deficit that year.

And as economist Richard Duncan points out at Macro Watch, it’s not just the Fed financing government deficits this way.

The Bank of England owns 26% of all British government debt. That means the ratio of government debt to GDP is not 84% as it is reported to be. It is actually 58%. This reality completely undermines the case for growth-retarding austerity in Britain.

The Bank of Japan owns Japanese government bonds equivalent to 22% of Japan’s GDP. When it is understood that QE is debt cancellation, the BoJ’s very aggressive Quantitative Easing program makes sense. It may be the only way to prevent a fiscal crisis in Japan.

The European Central Bank’s plans to create €1.1 trillion over the next 20 months will effectively cancel the combined budget deficits of the euro-zone national governments in both 2015 and 2016, with a considerable amount left over.