Thursday, August 27, 2009

Excellent Report by Chris Martenson on Debt Monetization

An excellent report was posted by Chris Martenson on surreptitious debt monetization by the FED, which I encountered as a link, once again, on Gary North's website:

The Federal Reserve has effectively been monetizing far more US government debt than has openly been revealed, by cleverly enabling foreign central banks to swap their agency debt for Treasury debt. This is not a sign of strength and reveals a pattern of trading temporary relief for future difficulties.

This is very nearly the same path that Zimbabwe took, resulting in the complete abandonment of the Zimbabwe dollar as a unit of currency. The difference is in the complexity of the game being played, not the substance of the actions themselves.

It actually is a relatively complex process, and I would imagine that the report will be difficult for most people to understand without a fairly good grasp of central banking. I will try to give a reasonably good summary:
  • The Treasury of the US government raises money to finance its deficits by selling debt certificates at auctions
  • Because the Treasury is running such high deficits in a period of recession, there is concern that there will not be enough buyers at these auctions, which will cause interest rates to rise, the costs of deficit spending to increase, and could spark a panic on the dollar
  • The FED, therefore, would like to buy the Treasuries with money created out of thin air, e.g. "monetize the debt," in order to artificially increase demand for these certificates and ensure that these auctions go smoothly
  • For a number of reasons, the FED cannot directly buy Treasury debt at auction
  • Instead, the FED prints money to buy other forms of debt called "Agency Debt," which includes mortgage backed securities and foreign central bank debt, under an agreement that the sellers of these securities will use the money to buy Treasury debt on behalf of the FED
In this fashion, the FED effectively monetizes the debt without making it look like the FED is monetizing the debt. In reality, the credit market is like any other: certificates swap hands among buyers and sellers on the basis of their perceived value by market participants. It doesn't matter which certificates the FED prints money to buy, it will increase the prices of all certificates in the market (e.g. lower interest rates) so long as the issuer of the particular certificate in question is still considered financially sound. So this doesn't necessarily mean that any grand conspiracy is in play here, with the exception of the fully public and accepted conspiracy of central banks to suppress interest rates in general rather than for their own Treasuries in particular. And as debt certificates go, government debt is generally trusted more so than private debt, for obvious reasons, so the plan works so long as the solvency of government in particular does not come into question. As he notes, nobody else has yet written that they thought the goal of the massive purchases of various debt instruments by the FED was to fund government deficits. That hasn't changed the fact that this has been the result, for the reasons discussed above. On the other hand, and as Martenson reports, the FED has refused every attempt to audit it. This would, naturally, imply that there is more to the story than the FED would like to admit. Who knows? At the end of the day it doesn't really matter. The government will eventually face bankruptcy; with present deficits, sooner rather than later. At that point, the FED will have to inflate these debts away or face governmental collapse. The dollar and the US government cannot both survive.

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