February 01, 2011

Welcome to the Midway


Something in a comment on a Zerohedge post rocked my thinking: the United States government is now in a position where it needs to borrow one-half trillion dollars every three months just to stay in business. One arrives at this conclusion by considering that the official deficit is $1.5 trillion, which is the difference between tax revenues and federal outlays, and then noting that the national debt grows by $2 trillion per year, reflecting that the Treasury must also borrow money in order to pay maturing (rollover) obligations coming due, with Niagara-like relentlessness, on an ongoing basis.


When you think about things like that, you begin asking yourself: Does America even have an economy? We may, in fact, have entered a period which one could call the Postmodern Economy, one in which almost all income-producing activity is accomplished by illusion and sleight-of-hand. The fiscal position of the U.S. government, in this sense, is simply illustrative of the underlying reality, or lack thereof. America has become completely dependent on its status as the printer of the world's reserve currency. That is not only our ace in the hole, it is our entire hand at this point.

Consider that the Federal Reserve Bank is now the single largest holder of Treasury debt in the world, bigger than China, bigger than Japan. This fact alone must cause a thoughtful person to wonder just what the hell is going on. How can the Federal Reserve Bank, which is the bank where the Treasury Department maintains the U.S. checking account, and is in some ways the alter ego of the Treasury Department, also be a creditor of the U.S. government, especially when the Federal Reserve Bank is also the entity responsible for creating U.S. money in the first place? How can an entity which creates money at will for the debtor become a creditor of the entity which it creates the money for?

Add to this observation that the "debt" which the Federal Reserve Bank holds is "purchased" by the Bank with money which it creates out of thin air. The Permanent Open Market Operations (POMO) of the Federal Reserve are illustrative of the shell game methods by which this is accomplished. The Treasury auctions off bonds of a certain duration. Among the participants in such auctions are the Primary Dealers (PDs), a group of 18 banks and broker-dealers which are required, in order to avail themselves of the many benefits of being in the In Crowd, to participate in such auctions. Let us say that the PDs take down about 50% of the total auction, and let's say the total auction equals $15 billion. Thus, Goldman Sachs, JPMorgan, Bank of America, et al, pay in $7.5 billion. A short time later, often the next week, the Fed conducts a POMO in which it goes into the "open market" and offers to buy back the same Treasuries which were just auctioned off. The PDs then regurgitate a significant fraction of the bonds which they just bought back at the Fed, often selling at a premium, functioning, I guess, as some sort of reward for their cooperation in keeping the shell game going.

Where does the Fed get the "money" to "buy" these Treasuries from the (very) recent purchasers? It creates the money out of thin air. Now ask yourself a simple question: is there a material difference between what just happened and the Treasury simply buying its own debt? One might point out that the Fed has only purchased a "fraction" of the just-sold bonds. True, but that's for each POMO operation, and the Fed just keeps buying, with at least $600 billion planned for the latest go-round of Quantitative Easing. Another question is equally obvious: would the PDs, the Kool Kids on Wall Street, even bother with these ultra low yield instruments if they did not know the Fed was planning to buy them all back, plus a kicker, in the next week or so?

The Treasury's ability to raise money through bond auctions, in other words, is heavily subsidized by the actions of its own bank in creating an immediate secondary market for the stuff it sells, and that bank, the Fed, creates the money for the secondary market by hallucinating it into existence.

We do not need to be detained by shell games, since we are innocent bystanders not directly involved in this conspiracy. We can collapse the process and simplify terms, using Occam's Razor to avoid the multiplicity of entities involved. If we simply equate the Fed to the Treasury and call it the TRED, for example, then we can see that what is really happening is that the TRED, or the Treasury itself, is creating the money to buy its own "debt" to a significant fraction of the total debt issued, probably at least on the order of 50%, and this fraction is increasing. Thus, while Ben Bernanke has sworn under oath that the Federal Reserve would not monetize debt, this, in fact, is exactly what the Fed is doing: it is monetizing America's huge, gaping deficits by printing money and running it through a complicated shell game to conceal just how close we are to the abyss, and to hide the very scary truth that no natural, realistic market for American debt exists at any interest rate which the country could afford to pay for the amounts of trash we need to issue to keep the game going.

An organic, actual economy, of the kind the United States once had, where Americans had real jobs and made real money, and sold actual stuff to foreign markets, and where large percentages of the American populace were engaged in productive activities such as agriculture and building cars and fabricating steel, produces a tax base which allows the federal government to function more or less in balance with the underlying activity. That American economy is gone, hollowed out by globalization and the impoverishment of the populace. About 47% of the American working age population actually has a real, full-time job. All kinds of games can be played with metrics such as U-3 and U-6, with its many categories of part-time, marginally attached, discouraged, etc., but those figures are strictly for the election cycle and for the economics departments of universities with close government connections. They do not reflect the underlying reality in the country. Close to 50 million Americans receive food stamps so they can eat. That is about 16% of the entire population.

Anyway, I think I answered my own question.

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