Federal Reserve sets stage for Weimar-style Hyperinflation
By F. William
Engdahl, 15 December, 2008
The Federal
Reserve has bluntly refused a request by a major US financial news service to
disclose the recipients of more than $2 trillion of emergency loans from US
taxpayers and to reveal the assets the central bank is accepting as collateral.
Their lawyers resorted to the bizarre argument that they did so to protect
'trade secrets.' Is the secret that the US financial system is de facto
bankrupt? The latest Fed move is further indication of the degree of panic and
lack of clear strategy within the highest ranks of the US financial
institutions. Unprecedented Federal Reserve expansion of the Monetary Base in
recent weeks sets the stage for a future Weimar-style hyperinflation perhaps
before 2010.
On November 7 Bloomberg filed suit under the US Freedom of Information Act
(FOIA) requesting details about the terms of eleven new Federal Reserve lending
programs created during the deepening financial crisis.
The Fed responded on December 8 claiming it's allowed to withhold internal
memos as well as information about 'trade secrets' and 'commercial
information.' The central bank did confirm that a records search found 231
pages of documents pertaining to the requests.
The Bernanke Fed in recent weeks has stepped in to take a role that was the
original purpose of the Treasury's $700 billion Troubled Asset Relief Program
(TARP). The difference between a Fed bailout of troubled financial institutions
and a Treasury bailout is that central bank loans do not have the oversight
safeguards that Congress imposed upon the TARP. Perhaps those are the 'trade
secrets the hapless Fed Chairman,Ben Bernanke, is so jealously guarding from
the public.
Coming hyperinflation?
The total of
such emergency Fed lending exceeded $2 trillion on Nov. 6. It had risen by an
astonishing 138 percent, or $1.23 trillion, in the 12 weeks since Sept. 14,
when central bank governors relaxed collateral standards to accept securities
that weren't rated AAA. They did so knowing that on the following day a
dramatic shock to the financial system would occur because they, in concert
with the Bush Administration, had decided to let it occur.
On September 15 Bernanke, New York Federal Reserve President, Tim Geithner, the
new Obama Treasury Secretary-designate, along with the Bush Administration,
agreed to let the fourth largest investment bank, Lehman Brothers, go bankrupt,
defaulting on untold billions worth of derivatives and other obligations held
by investors around the world. That event, as is now widely accepted, triggered
a global systemic financial panic as it was no longer clear to anyone what
standards the US Government was using to decide which institutions were 'too
big to fail' and which not. Since then the US Treasury Secretary has reversed
his policies on bank bailouts repeatedly leading many to believe Henry Paulson
and the Washington Administration along with the Fed have lost control.
In response to the deepening crisis, the Bernanke Fed has decided to expand
what is technically called the Monetary Base, defined as total bank reserves
plus cash in circulation, the basis for potential further high-powered bank
lending into the economy. Since the Lehman Bros. default, this money expansion
rose dramatically by end October at a year-year rate of growth of 38%, has been
without precedent in the 95 year history of the Federal Reserve since its
creation in 1913. The previous high growth rate, according to US Federal
Reserve data, was 28% in September 1939, as the US was building up industry for
the evolving war in Europe.
By the first week of December, that expansion of the monetary base had jumped
to a staggering 76% rate in just 3 months. It has gone from $836 billion in
December 2007 when the crisis appeared contained, to $1,479 billion in December
2008, an explosion of 76% year-on-year. Moreover, until September 2008, the
month of the Lehman Brothers collapse, the Federal Reserve had held the
expansion of the Monetary Base virtually flat. The 76% expansion has almost
entirely taken place within the past three months, which implies an annualized
expansion rate of more than 300%.
Despite this, banks do not lend further, meaning the US economy is in a
depression free-fall of a scale not seen since the 1930's. Banks do not lend in
large part because under Basle BIS lending rules, they must set aside 8% of
their capital against the value of any new commercial loans. Yet the banks have
no idea how much of the mortgage and other troubled securities they own are
likely to default in the coming months, forcing them to raise huge new sums of
capital to remain solvent. It's far 'safer' as they reason to pass on their
toxic waste assets to the Fed in return for earning interest on the acquired
Treasury paper they now hold. Bank lending is risky in a depression.
Hence the banks exchange $2 trillion of presumed toxic waste securities
consisting of Asset-Backed Securities in sub-prime mortgages, stocks and other
high-risk credits in exchange for Federal Reserve cash and US Treasury bonds or
other Government securities rated (still) AAA, i.e. risk-free. The result is
that the Federal Reserve is holding some $2 trillion in largely junk paper from
the financial system. Borrowers include Lehman Brothers, Citigroup and JPMorgan
Chase, the US's largest bank by assets. Banks oppose any release of information
because that might signal 'weakness' and spur short-selling or a run by
depositors.
Making the situation even more drastic is the banking model used first by US
banks beginning in the late 1970's for raising deposits, namely the acquiring
of 'wholesale deposits' by borrowing from other banks on the overnight
interbank market. The collapse in confidence since the Lehman Bros. default is
so extreme that no bank anywhere, dares trust any other bank enough to borrow. That
leaves only traditional retail deposits from private and corporate savings or
checking accounts.
To replace wholesale deposits with retail deposits is a process that in the
best of times will take years, not weeks. Understandably, the Federal Reserve
does not want to discuss this. That is clearly also behind their blunt refusal
to reveal the nature of their $2 trillion assets acquired from member banks and
other financial institutions. Simply put, were the Fed to reveal to the public
precisely what 'collateral' they held from the banks, the public would know the
potential losses that the government may take.
Congress is demanding more transparency from the Federal Reserve and US
Treasury on its bailout lending. On December 10 in Congressional hearings by
the House Financial Services Committee, Representative David Scott, a Georgia
Democrat, said Americans had 'been bamboozled,' slang for defrauded.
Hiccups and
Hurricanes
Fed Chairman
Ben S. Bernanke and Treasury Secretary Henry Paulson said in September they
would meet congressional demands for transparency in a $700 billion bailout of
the banking system. The Freedom of Information Act obliges federal agencies to
make government documents available to the press and public.
In early December the Congress oversight agency, GAO, issued its first mandated
review of the lending of the US Treasury's $700 billion TARP program (Troubled
Asset Relief Program). The review noted that in 30 days since the program
began, Henry Paulson's office had handed out $150 billion of taxpayer money to
financial institutions with no effective accountability of how the money is
being used. It seems Henry Paulson's Treasury has indeed thrown a giant 'tarp'
over the entire taxpayer bailout.
Further adding to the troubles in the world's former financial Mecca, the US
Congress, acting on largely ideological grounds, shocked the financial system
when it refused to give even a meager $14 billion emergency loan to the Big
Three automakers-General Motors, Chrysler and Ford.
While it is likely that the Treasury will extend emergency credit to the
companies until January 20 or until the newly elected Congress can consider a
new plan, the prospect of a chain-reaction bankruptcy collapse of the three
giant companies is very near. What is being left out of the debate is that
those three companies account for a combined 25% of all US corporate bonds
outstanding. They are held by private pension funds, mutual funds, banks and
others. If the auto parts suppliers of the Big Three are included, an estimated
$1 trillion of corporate bonds are now at risk of chain-reaction default. Such
a bankruptcy failure could trigger a financial catastrophe which would make
what has happened since Lehman Bros. appear as a mere hiccup in a hurricane.
As well, the Federal Reserve's panic actions since September, by their
explosive expansion of the monetary base, has set the stage for a
Zimbabwe-style hyperinflation. The new money is not being 'sterilized' by
offsetting actions by the Fed, a highly unusual move indicating their
desperation. Prior to September the Fed's infusions of money were sterilized,
making the potential inflation effect 'neutral.'
Defining a Very Great Depression
That means once
banks begin finally to lend again, perhaps in a year or so, that will flood the
US economy with liquidity in the midst of a deflationary depression. At that
point or perhaps well before, the dollar will collapse as foreign holders of US
Treasury bonds and other assets run. That will not be pleasant as the result
would be a sharp appreciation in the Euro and a crippling effect on exports in
Germany and elsewhere should the nations of the EU and other non-dollar
countries such as Russia, OPEC members and, above all, China not have arranged
a new zone of stabilization apart from the dollar.
The world faces the greatest financial and economic challenges in history in
coming months. The incoming Obama Administration faces a choice of literally nationalizing
the credit system to insure a flow of credit to the real economy over the next
5 to 10 years, or face an economic Armageddon that will make the 1930's appear
a mild recession by comparison.
Leaving aside what appears to have been blatant political manipulation by the
present US Administration of key economic data prior to the November election
in a vain attempt to downplay the scale of the economic crisis in progress, the
figures are unprecedented. For the week ended December 6 initial jobless claims
rose to the highest level since November 1982. More than four million workers
remained on unemployment, also the most since 1982 and in November US companies
cut jobs at the fastest rate in 34 years. Some 1,900,000 US jobs have vanished
so far in 2008.
As a matter of relevance, 1982, for those with long memories, was the depth of
what was then called the Volcker Recession. Paul Volcker, a Chase Manhattan
appendage of the Rockefeller family, had been brought down from New York to
apply his interest rate 'shock therapy' to the US economy in order as he put
it, 'to squeeze inflation out of the economy.' He squeezed far more as the
economy went into severe recession, and his high interest rate policy detonated
what came to be called the Third World Debt Crisis. The same Paul Volcker has
just been named by Barack Obama as chairman-designate of the newly formed
President's Economic Recovery Advisory Board, hardly grounds for cheer.
The present economic collapse across the United States is driven by the collapse
of the $3 trillion market for high-risk sub-prime and Alt-A home mortgages. Fed
Chairman Bernanke is on record stating that the worst should be over by end of
December. Nothing could be farther from the truth, as he well knows. The same
Bernanke stated in October 2005 that there was 'no housing bubble to go bust.' So
much for the predictive quality of that Princeton economist. The widely-used
S&P Schiller-Case US National Home Price Index showed a 17% year-year drop
in the third Quarter, trend rising. By some estimates it will take another five
to seven years to see US home prices reach bottom. In 2009 as interest rate
resets on some $1 trillion worth of Alt-A US home mortgages begin to kick in,
the rate of home abandonments and foreclosures will explode. Little in any of
the so-called mortgage amelioration programs offered to date reach the vast
majority affected. That process in turn will accelerate as millions of
Americans lose their jobs in the coming months.
John Williams of the widely-respected Shadow Government Statistics report,
recently published a definition of Depression, a term that was deliberately
dropped after World War II from the economic lexicon as an event not
repeatable. Since then all downturns have been termed 'recessions.' Williams
explained to me that some years ago he went to great lengths interviewing the
respective US economic authorities at the Commerce Department's Bureau of
Economic Analysis and at the National Bureau of Economic Research (NBER), as
well as numerous private sector economists, to come up with a more precise
definition of 'recession,' 'depression' and 'great depression.' His is pretty
much the only attempt to give a more precise definition to these terms.
What he came up with was first the official NBER definition of recession: Two
or more consecutive quarters of contracting real GDP, or measures of payroll
employment and industrial production. A depression is a recession in which the
peak-to-bottom growth contraction is greater than 10% of the GDP. A Great Depression
is one in which the peak-to-bottom contraction, according to Williams, exceeds
25% of GDP.
In the period from August 1929 until he left office President Herbert Hoover
oversaw a 43-month long contraction of the US economy of 33%. Barack Obama
looks set to break that record, to preside over what historians could likely
call the Very Great Depression of 2008-2014, unless he finds a new cast of
financial advisers before Inauguration Day, January 20. Required are not
recycled New York Fed presidents, Paul Volckers or Larry Summers types. Needed
is a radically new strategy to put virtually the entire United States economy
into some form of an emergency 'Chapter 11' bankruptcy reorganization where
banks take write-offs of up to 90% on their toxic assets, that, in order to
save the real economy for the American population and the rest of the world. Paper
money can be shredded easily. Not human lives. In the process it might be time
for Congress to consider retaking the Federal Reserve into the Federal
Government as the Constitution originally specified, and make the entire
process easier for all. If this sounds extreme, perhaps revisit this article in
six months again.