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Federal Reserve sets stage for Weimar-style hyperinflation
F. William Engdahl
Online
Journal
Tuesday, Dec 16, 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 11 new Federal
Reserve lending programs created during the deepening financial
crisis.
(ARTICLE CONTINUES BELOW)
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 the end of October at a year-year rate of growth of 38 percent,
which has been without precedent in the 95-year history of the
Federal Reserve created in 1913. The previous high growth rate,
according to US Federal Reserve data, was 28 percent 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 percent rate in just three
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 percent 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 percent expansion has almost entirely taken place within the
past three months, which implies an annualized expansion rate
of more than 300 percent.
Despite this, banks do not lend further, meaning the US economy
is in a depression free-fall of a scale not seen since the 1930s.
Banks do not lend in large part because under Basle BIS lending
rules, they must set aside 8 percent 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’
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 subprime 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 1970s 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 Government Accountability Office (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 percent 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 five
to 10 years, or face an economic Armageddon that will make the
1930s appear a mild recession by comparison.
Leaving aside what appears to have been blatant political manipulation
by the present Bush 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 4 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 subprime
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 further 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 percent 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 percent of the GDP. A Great Depression
is one in which the peak-to-bottom contraction, according to Williams,
exceeds 25 percent 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 percent. 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 percent on their toxic assets, 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, revisit this article in six months.
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