The January outlook from Pimco's Bill Gross:
It was Milton Friedman, not Ben Bernanke, who first made reference to dropping money from helicopters in order to prevent deflation. Bernankeâs now famous âhelicopter speechâ in 2002, however, was no less enthusiastically supportive of the concept. In it, he boldly previewed the almost unimaginable policy solutions that would follow the black swan financial meltdown in 2008: policy rates at zero for an extended period of time; expanding the menu of assets that the Fed buys beyond Treasuries; and of course quantitative easing purchases of an almost unlimited amount should they be needed. These werenât Bernanke innovations â nor was the term QE. Many of them had been applied by policy authorities in the late 1930s and â40s as well as Japan in recent years. Yet the then Fed Governorâs rather blatant support of monetary policy to come should have been a signal to investors that he would be willing to pilot a helicopter should the takeoff be necessary. âLike gold,â he said, âU.S. dollars have value only to the extent that they are strictly limited in supply. But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost.â
Mr. Bernanke never provided additional clarity as to what he meant by âno cost.â Perhaps he was referring to zero-bound interest rates, although at the time in 2002, 10-year Treasuries were at 4%. Or perhaps he knew something that American citizens, their political representatives, and almost all investors still donât know: that quantitative easing â the purchase of Treasury and Agency mortgage obligations from the private sector â IS essentially costless in a number of ways. That might strike almost all of us as rather incredible â writing checks for free â but that in effect is what a central bank does. Yet if ordinary citizens and corporations canât overdraft their accounts without criminal liability, how can the Fed or the European Central Bank or any central bank get away with printing âelectronic moneyâ and distributing it via helicopter flyovers in the trillions and trillions of dollars?
Well, the answer is sort of complicated but then itâs sort of simple: They just make it up. When the Fed now writes $85 billion of checks to buy Treasuries and mortgages every month, they really have nothing in the âbankâ to back them. Supposedly they own a few billion dollars of âgold certificatesâ that represent a fairy-tale claim on Ft. Knoxâs secret stash, but thereâs essentially nothing there but trust. When a primary dealer such as J.P. Morgan or Bank of America sells its Treasuries to the Fed, it gets a âcreditâ in its account with the Fed, known as âreserves.â It can spend those reserves for something else, but then another bank gets a credit for its reserves and so on and so on. The Fed has told its member banks âTrust me, we will always honor your reserves,â and so the banks do, and corporations and ordinary citizens trust the banks, and âthe beat goes on,â as Sonny and Cher sang. $54 trillion of credit in the U.S. financial system based upon trusting a central bank with nothing in the vault to back it up. Amazing!
But the story doesnât end here. What I have just described is a rather routine textbook explanation of how central and fractional reserve banking works its productive yet potentially destructive magic. What Governor Bernanke may have been referring to with his âessentially freeâ comment was the fact that the Fed and other central banks such as the Bank of England (BOE) actually rebate the interest they earn on the Treasuries and Gilts that they buy. They give the interest back to the government, and in so doing, the Treasury issues debt for free. Theoretically itâs the profits of the Fed that are returned to the Treasury, but the profits are the interest on the $2.5 trillion worth of Treasuries and mortgages that they have purchased from the market. The current annual remit amounts to nearly $100 billion, an amount that permits the Treasury to reduce its deficit by a like amount. When the Fed buys $1 trillion worth of Treasuries and mortgages annually, as it is now doing, it effectively is financing 80% of the deficit for free.
The BOE and other central banks work in a similar fashion. British Chancellor of the Exchequer (equivalent to our Treasury Secretary) George Osborne wrote a letter to Mervyn King, Governor of the BOE (equivalent to our Fed Chairman) in November. âTransferring the net income from the APF [Asset Purchase Facility â Britainâs QE] will allow the Government to manage its cash more efficiently, and should lead to debt interest savings to central government in the short-term.â Savings indeed! The Exchequer issues gilts, the BOEâs QE program buys them and then remits the interest back to the Exchequer. As shown in Chart 1, the worldâs six largest central banks have collectively issued six trillion dollarsâ worth of checks since the beginning of 2009 in order to stem private sector delevering. Treasury credit is being backed with central bank credit with the interest then remitted to its issuer. Should interest rates rise and losses accrue to the Fedâs portfolio, they record it as an accounting liability owed to the Treasury, which need never be paid back. This is about as good as it can get folks. Money for nothing. Debt for free.
Read the full article here.
It was Milton Friedman, not Ben Bernanke, who first made reference to dropping money from helicopters in order to prevent deflation. Bernankeâs now famous âhelicopter speechâ in 2002, however, was no less enthusiastically supportive of the concept. In it, he boldly previewed the almost unimaginable policy solutions that would follow the black swan financial meltdown in 2008: policy rates at zero for an extended period of time; expanding the menu of assets that the Fed buys beyond Treasuries; and of course quantitative easing purchases of an almost unlimited amount should they be needed. These werenât Bernanke innovations â nor was the term QE. Many of them had been applied by policy authorities in the late 1930s and â40s as well as Japan in recent years. Yet the then Fed Governorâs rather blatant support of monetary policy to come should have been a signal to investors that he would be willing to pilot a helicopter should the takeoff be necessary. âLike gold,â he said, âU.S. dollars have value only to the extent that they are strictly limited in supply. But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost.â
Mr. Bernanke never provided additional clarity as to what he meant by âno cost.â Perhaps he was referring to zero-bound interest rates, although at the time in 2002, 10-year Treasuries were at 4%. Or perhaps he knew something that American citizens, their political representatives, and almost all investors still donât know: that quantitative easing â the purchase of Treasury and Agency mortgage obligations from the private sector â IS essentially costless in a number of ways. That might strike almost all of us as rather incredible â writing checks for free â but that in effect is what a central bank does. Yet if ordinary citizens and corporations canât overdraft their accounts without criminal liability, how can the Fed or the European Central Bank or any central bank get away with printing âelectronic moneyâ and distributing it via helicopter flyovers in the trillions and trillions of dollars?
Well, the answer is sort of complicated but then itâs sort of simple: They just make it up. When the Fed now writes $85 billion of checks to buy Treasuries and mortgages every month, they really have nothing in the âbankâ to back them. Supposedly they own a few billion dollars of âgold certificatesâ that represent a fairy-tale claim on Ft. Knoxâs secret stash, but thereâs essentially nothing there but trust. When a primary dealer such as J.P. Morgan or Bank of America sells its Treasuries to the Fed, it gets a âcreditâ in its account with the Fed, known as âreserves.â It can spend those reserves for something else, but then another bank gets a credit for its reserves and so on and so on. The Fed has told its member banks âTrust me, we will always honor your reserves,â and so the banks do, and corporations and ordinary citizens trust the banks, and âthe beat goes on,â as Sonny and Cher sang. $54 trillion of credit in the U.S. financial system based upon trusting a central bank with nothing in the vault to back it up. Amazing!
But the story doesnât end here. What I have just described is a rather routine textbook explanation of how central and fractional reserve banking works its productive yet potentially destructive magic. What Governor Bernanke may have been referring to with his âessentially freeâ comment was the fact that the Fed and other central banks such as the Bank of England (BOE) actually rebate the interest they earn on the Treasuries and Gilts that they buy. They give the interest back to the government, and in so doing, the Treasury issues debt for free. Theoretically itâs the profits of the Fed that are returned to the Treasury, but the profits are the interest on the $2.5 trillion worth of Treasuries and mortgages that they have purchased from the market. The current annual remit amounts to nearly $100 billion, an amount that permits the Treasury to reduce its deficit by a like amount. When the Fed buys $1 trillion worth of Treasuries and mortgages annually, as it is now doing, it effectively is financing 80% of the deficit for free.
The BOE and other central banks work in a similar fashion. British Chancellor of the Exchequer (equivalent to our Treasury Secretary) George Osborne wrote a letter to Mervyn King, Governor of the BOE (equivalent to our Fed Chairman) in November. âTransferring the net income from the APF [Asset Purchase Facility â Britainâs QE] will allow the Government to manage its cash more efficiently, and should lead to debt interest savings to central government in the short-term.â Savings indeed! The Exchequer issues gilts, the BOEâs QE program buys them and then remits the interest back to the Exchequer. As shown in Chart 1, the worldâs six largest central banks have collectively issued six trillion dollarsâ worth of checks since the beginning of 2009 in order to stem private sector delevering. Treasury credit is being backed with central bank credit with the interest then remitted to its issuer. Should interest rates rise and losses accrue to the Fedâs portfolio, they record it as an accounting liability owed to the Treasury, which need never be paid back. This is about as good as it can get folks. Money for nothing. Debt for free.
Read the full article here.
