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How To
Reverse A Deflation: Helicopter Ben Needs To Drop Some
Money On Main Street
14 September 2010
By Ellen Brown
The Fed is proposing another round of “quantitative
easing,” although the first round failed to reverse
deflation. It failed because the money went into the
coffers of banks, which failed to lend it on. To
reverse deflation, the money needs to be funneled
directly to state and local economies.
In 2002, in a speech that earned him the nickname
“Helicopter Ben,” then-Fed Governor Bernanke famously
said that the government could easily reverse a
deflation, just by printing money and dropping it from
helicopters.
“The U.S. government has a technology, called a
printing press (or, today, its electronic
equivalent),” he said, “that allows it to produce as
many U.S. dollars as it wishes at essentially no
cost.” Later in the speech he discussed “a
money-financed tax cut,” which he said was
“essentially equivalent to Milton Friedman’s famous
‘helicopter drop’ of money.” You could cure a
deflation, said Professor Friedman, simply by dropping
money from helicopters.
It seems logical enough. If there is insufficient
money in the money supply (deflation), the solution is
to put more money into it. But if deflation is so
easy to fix, then why has the Fed’s massive attempts
to date failed to do the job?
At the Federal Reserve’s Jackson Hole summit on August
27, Chairman Bernanke said he would fight deflation
with his whole arsenal, including “quantitative
easing” (QE) – purchasing longterm securities with
money created on a computer. Yet since
2008, the Fed has added more than $1.2 trillion to
“base money” doing just that, and the economy is still
in a serious deflationary spiral. In the first
quarter of this year, the money supply actually shrank
at a record annual rate of 9.6%.
Cullen Roche at The Pragmatic Capitalist has an answer
to that puzzle. He says that as currently practiced,
quantitative easing (QE) is not really a money
drop. It is just an asset swap:
“[T]he Fed doesn’t
actually ‘print’ anything when it initiates its QE
policy. The Fed simply electronically swaps an asset
with the private sector. In most cases it swaps
deposits with an interest bearing asset.”
The Fed just swaps Federal Reserve Notes (dollar
bills) for other assets (promissory notes or debt)
that can quickly be turned into money. The Fed is
merely trading one form of liquidity for another,
without raising the overall water level in the pool.
The mechanics of how QE works were revealed in a
remarkable segment on National Public Radio on August
26, describing how a team of Fed employees bought
$1.25 trillion in mortgage bonds beginning in late
2008. According to NPR:
“The Fed was able to
spend so much money so quickly because it has a unique
power: It can create money out of thin air, whenever
it decides to do so. So . . . the mortgage team would
decide to buy a bond, they’d push a button on the
computer – ‘and voila, money is created.’
“The thing about bonds, of course, is that people pay
them back. So that $1.25 trillion in mortgage bonds
will shrink over time, as they get repaid. Earlier
this month, the Fed announced that it will use the
proceeds from the mortgage bonds to buy Treasury bonds
– essentially keeping all that newly created money in
circulation. The decision was a sign that the Fed
thinks the economy still needs to be propped up with
extraordinary measures.”
“Extraordinary measures” was a reference to Section
13(3) of the Federal Reserve Act, which allows the Fed
in “unusual and exigent circumstances” to buy “notes,
drafts and bills of exchange” (debt instruments) from
“any individual, partnership or corporation”
satisfying its requirements. The Fed was supposedly
engaging in these extraordinary measures to “reflate”
the money supply and get credit flowing again. Yet
the money supply continued to shrink. The problem, as
Roche explains, is that the dollars were merely being
swapped for other highly liquid assets on bank balance
sheets. That this sort of asset swap will not pump up
a collapsed money supply has been shown not only by
the Fed’s failed experiments over the last two years
but by two decades of failed QE policy in Japan, an
economy which remains in the deflationary doldrums.
To reverse deflation, it seems, QE needs to be
directed somewhere else besides the balance sheets of
private banks. What we need is the sort of helicopter
drop described by Bernanke in 2002 – one over the
towns and cities of the real economy.
There is another interesting lesson suggested by
two decades of failed QE: it might actually be
possible for the government to “print” its way out of
debt, without triggering the dreaded hyperinflation
long warned of by pundits. Swapping dollars for debt
hasn’t inflated the circulating money supply to date
because federal debt securities already serve as forms
of “money” in the economy.
The Textbook Money Multiplier
Model . . . And Why It Is Obsolete
Beginning with some definitions, “quantitative easing”
is explained in Wikipedia like this:
“A central bank . . . first credit[s] its own account
with money it has created ex nihilo (‘out
of nothing’). It
then purchases financial assets, including government
bonds, mortgage-backed securities and corporate bonds,
from banks and other financial institutions in
a process referred to as open market operations. The
purchases, by way of account deposits, give banks the
excess reserves required for them to create new money,
and thus a hopeful stimulation of the economy,
by the process of
deposit multiplication from increased lending in the
fractional reserve banking system.”
“Deposit multiplication” is the textbook explanation
for how credit expands as it circulates through the
economy. In the textbook model, banks must retain
“reserves” equal to 10% of outstanding deposits
(including deposits created as loans). With a 10%
reserve requirement, a $100 deposit can support a $90
loan, which gets deposited in another bank, where it
becomes an $81 loan, and so forth, until a $100
deposit becomes $1,000 in credit-money.
The theory is that increasing the banks’ reserves will
stimulate this process, but both the Federal Reserve
and the Bank for International Settlements (BIS) now
concede that the process has not been working in the
textbook way. (The BIS is “the central bankers’
central bank” in Basel, Switzerland.) The futile
effort to push more money into bloated bank reserve
accounts has been compared to adding more apples to
shelves that are already overstocked with apples.
Adding more reserves to a banking system that already
has more reserves than it can use has no net
effect on the money supply.
The failure of QE either to increase bank lending or
to inflate the money supply was confirmed in a March
24 paper by Federal Reserve Vice
Chairman
Donald L. Kohn, who wrote:
“The huge quantity of bank reserves that were created
[by quantitative easing] has been seen largely as a
byproduct of the purchases [of debt instruments] that
would be unlikely to have a significant independent
effect on financial markets and the economy. This view
is not consistent with the simple models in many
textbooks or the monetarist tradition in monetary
policy, which emphasizes a line of causation from
reserves to the money supply to economic activity and
inflation.”
The textbook model is obsolete because banks don’t
make lending decisions based on how many reserves they
have. They can always get the reserves they need. If
customers don’t walk in the door with new deposits,
the bank can borrow deposits from other banks,
something they can now do at the very low Fed funds
rate of .2% (1/5th of 1%). And if those
deposits are not available, the Federal Reserve itself
will supply the reserves. This was confirmed in a BIS
working paper called “Unconventional Monetary
Policies: An Appraisal”, which observed:
“[T]he level of reserves
hardly figures in banks’ lending decisions. The amount
of credit outstanding is determined by banks’
willingness to supply loans, based on perceived
risk-return trade-offs, and by the demand for those
loans. . . .
“The aggregate
availability of bank reserves does not constrain the
expansion [of credit] directly. The reason is simple:
. . . in order to avoid extreme volatility in the
interest rate, central banks supply reserves as
demanded by the system. From this perspective, a
reserve requirement, depending on its remuneration,
affects the cost . . . of loans, but does not
constrain credit expansion quantitatively. . . . [A]n
expansion of reserves in excess of any requirement
does not give banks more resources to expand lending.
It only changes the composition of liquid assets of
the banking system. Given the very high
substitutability between bank reserves and other
government assets held for liquidity purposes, the
impact can be marginal at best.”
Again, one form of liquidity is just substituted
for another, without changing the overall level in the
pool.
If bank reserves do not constrain bank lending,
what does? According to the BIS paper, “the main . .
. constraint on the expansion of credit is minimum
capital requirements.” These capital requirements,
known as “Basel I” and “Basel II,” were imposed by the
BIS itself. It is interesting that the BIS knows that
the main constraints on bank lending are its own
capital requirements, yet it is talking about
raising them, in an economic climate in which
lending is already seriously impaired. Either the BIS
is talking out of both sides of its mouth, or its
writers don’t read each other.
A Solution to the Federal Debt Crisis?
Another interesting aside arising from all this is
the suggestion that the government could
actually print its way out of debt – it could print
dollars and buy back its bonds -- without
creating inflation. As Roche observes:
“[Quantitative easing]
in time of a balance
sheet recession is not actually inflationary at all.
With the government merely swapping assets they are
not actually ‘printing’ any new money. In fact, the
government is now essentially stealing interest
bearing assets from the private sector and replacing
them with deposits. . . . [T]his policy response
would in fact be deflationary – not
inflationary.”
Roche concludes,
“the inflationistas have been wrong and the USA
defaultistas have been horribly wrong.”
The “inflationistas” are the pundits screaming that QE
will end in hyperinflation, and the “defaultistas” are
those insisting that the U.S. must eventually default
on its debt. Representing both camps, for example, is
Richard Russell, who writes:
“In my opinion, the
US MUST default on its
debt.
There are two ways to default. One is simply to renege
on the debt. . . . The other way to default on the
debt is to inflate it away. I’m
absolutely convinced that this is the path that the US
will take. If the US inflates enough, then over time
(many years) the devalued dollar will tend to reduce
the power of the debts.”
The failed QE experiments in Japan
and the U.S. suggest, however, that there is a third
alternative. Printing dollars to pay the debt
(referred to by Russell as “inflating the debt away”)
might actually eliminate the debt without
creating inflation. This is because federal bonds and
Federal Reserve Notes are interchangeable forms of
liquidity. Government securities trade around the
world just as if they were money. A $100 bond
represents a claim on $100 worth of goods and
services, just as a $100 bill does. The difference,
as Thomas Edison said nearly a century ago, is merely
that “the bond lets money
brokers collect twice the amount of the bond and an
additional 20%, whereas the currency pays nobody but
those who contribute directly in some useful way. . .
. Both are promises to pay, but one promise fattens
the usurers and the other helps the people.”
The
Fed’s earlier attempts at QE involved swapping $1.25
trillion in mortgaged-backed securities (MBS) for
dollars created on a computer screen. As noted in the
NPR segment, many of those securities have come due
and have gotten paid off, putting cash in the Fed’s
till. The Fed now proposes to use this money to buy
long-term Treasury debt rather than MBS. That means
the Fed will, in effect, be buying the government’s
debt with dollars created on a computer screen. The
privately-owned Federal Reserve is not actually an arm
of the federal government, but if it were, the
government would thus be printing its way out of debt
– just as Helicopter Ben proposed in 2002.
Recall that he said, “the U.S. government
has a technology, called a printing press” – the U.S.
government, not the central bank that has done all the
QE to date.
Running the government’s printing
presses to pay its bills has not seriously been tried
since the Civil War, when President Lincoln saved the
North from a crippling war debt at usurious interest
rates by printing Greenbacks (U.S. Notes). Other
countries, however, have tested and proven this model
more recently. They include Germany, which pulled
itself out of a massive financial collapse in the
early 1930s by printing a form of currency called
“MEFO bills”; and Australia, New Zealand and Canada,
all of which successfully funded public works in the
first half of the twentieth century simply by
advancing the credit of the nation. China, Malaysia,
Guernsey, Jersey, India, Argentina and other countries
have also revived their economies at critical times by
this means. The U.S. government could do this too.
It could print dollars (or type them into electronic
bank accounts) and spend the money on the sorts of
local public projects that would put people back to
work and get the economy rolling again.
How to Reverse a Deflation: Do a
Helicopter Drop on the States
The government could pay its bills by issuing
Greenbacks as Lincoln did, but it probably won’t,
given the current deadlock in Congress. Today only
the Federal Reserve Chairman seems to be in a position
to act unilaterally, without asking anyone’s
permission. Chairman Bernanke could execute his own
plan and generate the credit needed to get the economy
churning again, by aiming his “quantitative easing”
tool at the states. After all, if Wall Street (which
got us into this mess) can borrow at .2%, underwritten
by the Fed as “lender of last resort,” then state and
local governments should be able to as well. Chairman
Bernanke could credit the Fed’s account with money
created ex nihilo (out of nothing) and swap it
for state and municipal bonds at the Fed funds rate.
A “state” might not qualify as an “individual,
partnership or corporation” under Section 13(3) of the
Federal Reserve Act, but a state-owned bank
would. Bruce Cahan, an attorney and social
entrepreneur in Silicon Valley, California, proposes
that the Fed could
diversify its role by buying long-term bonds in
existing or newly-chartered state-owned banks. These
banks, which would have a mandate to serve state and
local communities, would more quickly and accountably
lend for in-state purposes than private banks do now.
They could be required to use accepted transparency
accounting standards to trace how the proceeds of
their loans flowed into the economy. Local needs
would thus determine how best to jumpstart and keep
alive businesses and households that the “too big to
fail” megabanks no longer want to fund on fair credit
terms. Adding a state-owned bank would also bring
competition to regional banking markets such as that
of the
San Francisco Bay area, which are now dominated by
out-of-state megabanks. By funding state-owned banks,
the
Fed could inject “liquidity” where it is most needed,
in local markets where workers are hired and real
goods and services are sold.
Ellen Brown is an attorney
and the author of eleven books. In
Web of Debt, her latest book, she shows how
the Federal Reserve and "the money trust" have usurped
the power to create money from the people themselves,
and how we the people can get it back. Her websites
are
webofdebt.com,
ellenbrown.com, and
public-banking.com.
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