Karl Denninger is out with a vicious attack on Ron Paul that can only be described as proof he doesn't understand Federal Reserve monetary policy AND has a problem with reading comprehension.
Oh really? Let's step through it, shall we?
During an interview with Iowa radio host Jan Mickelson, Ron Paul called for the Treasury to stop making payments on Treasury securities held by the Federal Reserve. Congressman Paul pointed out that the Fed simply prints up new money when they buy Treasury securities, so there is no obligation to payback the Fed. He pointed out that through taxes, Americans are paying the interest on the Treasury securities owned by the Fed and this should also stop. As part of its $2.8 trillion balance sheet, the Federal Reserves holds $1.6 trillion in Treasury securities.
And here Wenzel goes right out the window.
The Fed remits all of the interest it "earns" in net income (after operating expenses) back to Treasury. That is, the interest that is allegedly "owed" to The Fed is actually paid to Treasury ex expenses of operation. Since Treasury would have to pay those operational expenses were it to do this on its own, the net is the same.
In other words, taxpayers are paying nothing.
How much has this been? Something like $80 billion last year!
So much for "The taxpayers would save so much money!"
I then said:
So let's think through Mr. Paul's "creative" solution. Destroying the bonds The Fed holds while leaving the "excess reserves" that are on deposit, which The Fed creates with a push of a button to pay for those bonds, is in fact exactly identical to unbacked emission of currency. That is, raw printing of money.
Yep. Emitting currency (digital dollars) in exchange for a bond is a loan. Doing so with nothing in exchange is raw printing of money.
Wenzel then gets one thing right:
Well not exactly. If banks are holding funds as excess reserves, those funds aren't in the system. They are back at the Fed.
Ah, but nothing compels them to hold excess reserves at The Fed. They're doing so for one reason - there is no productive place to lend them out to. This, incidentally, is the fallacy of "QE-anything" in terms of "helping the broader economy" - there is no shortage of funds to lend, but there is a huge shortage of qualified and willing borrowers!
But if the Treasury simply defaults on the obligations held by the Fed, this means there is $1.6 trillion less that the Treasury needs to raise in the markets and thus creates huge downward pressure on interest rates and makes it much easier for the Fed to make counter-moves to halt the excess reserves from entering the system.
The Treasury can't, under the 14th Amendment, default on those bonds. Never mind that a bond is a bond is a bond - you default on those and suddenly China thinks theirs are unsafe, and, well, what would you do in that instance?
More to the point, however, were Treasury to simply "tear up the bonds" the $1.6 trillion in excess reserves would be instantly unbacked by anything and yet still immediately available for the banks to withdraw and spend. And since there would be absolutely no obligation to ever return those funds (say, via taxation to retire the $1.6 trillion in treasuries that no longer exists!) this would be an immediate and permanent increase in the monetary base.
That's the definition of (monetary) inflation.
But if the Treasury simply defaults on the obligations held by the Fed, this means there is $1.6 trillion less that the Treasury needs to raise in the markets and thus creates huge downward pressure on interest rates and makes it much easier for the Fed to make counter-moves to halt the excess reserves from entering the system. There are many possible ways to do this. The text book way, that any student who has taken a Macroecnomics 101 course should be aware of, is for the Fed to simply raise the reserve requirement. Raising the reserve requirement would prevent any of the excess reserves from hitting the system.
Downward pressure on interest rates? What is Wenzel smoking over there? You declare on an arbitrary (and unlawful) basis that your debt is worthless by decree and all of the other holders would see this as an increase in the value (and thus depression of the rate) on their holdings?
On what planet?
As for raising reserve requirements I'm sure Welzel is aware that one of the perversities in TARP was the elimination of any formal reserve requirement in the law whatsoever. I wrote about it at the time. Bernanke has long argued that reserve requirements are "archaic" and, well, he got what he wanted.
There is no longer, as of the effective date of TARP, any formal and legal reserve requirement ensconced in law for US Banks. Bernanke is quite free to set that requirement to anything he desires, including zero.
In short, Denninger doesn't understand the very article he links to, which explains how the Federal Reserve has tools, specifically the reserve requirement , to deal with the excess reserves.
The hell I don't understand it.
QE (and QE2) did exactly one thing. It allowed the government to run deficits - that is, charge up the national credit card - at rates that were utterly unsupportable in the private marketplace. In aggregate this has totaled approximately $3.5 trillion beyond what Bush was doing from 2003-2007 (Bush himself was running ~$600 billion in unsustainable deficits.) Both were nothing more than an attempt to perpetuate this:
And keep this - the fact that we have not run one quarter of actual net positive GDP growth ex-debt accumulation since 1980, from collapsing around their ears:
The problem is that trying to save a Ponzi Scheme never works, because arithmetically it can't. The longer you keep at it the worse the damage is that you must absorb when, not if, it unwinds.
Where We Are, Where We're Heading (2013) - The annual 2013 Ticker
The content on this site is provided without any warranty, express or implied. All opinions expressed on this site are those of the author and may contain errors or omissions.
NO MATERIAL HERE CONSTITUTES "INVESTMENT ADVICE" NOR IS IT A RECOMMENDATION TO BUY OR SELL ANY FINANCIAL INSTRUMENT, INCLUDING BUT NOT LIMITED TO STOCKS, OPTIONS, BONDS OR FUTURES.
The author may have a position in any company or security mentioned herein. Actions you undertake as a consequence of any analysis, opinion or advertisement on this site are your sole responsibility.
Looking for "The Best of Market Ticker"? Check out Ticker Classics.
Market charts, when present, used with permission of TD Ameritrade/ThinkOrSwim Inc. Neither TD Ameritrade or ThinkOrSwim have reviewed, approved or disapproved any content herein.
The Market Ticker content may be reproduced or excerpted online for non-commercial purposes provided full attribution is given and the original article source is linked to. Please contact Karl Denninger for reprint permission in other media or for commercial use.
Submissions or tips on matters of economic or political interest may be sent "over the transom" to The Editor at any time. To be considered for publication your submission must include full and correct contact information and be related to an economic or political matter of the day. All submissions become the property of The Market Ticker.