by Ellen Brown
November 19, 2010
Ellen Brown is an attorney and the author of eleven books.
In Web of Debt:
The Shocking Truth About Our Money System, she shows how the Federal Reserve
and "the money trust" have usurped the power to create money from the people
themselves, and how we the people can get it back.
Her websites are webofdebt.com, ellenbrown.com,
The deficit hawks are circling, hovering over
calling it just another inflationary bank bailout.
But unlike QE1, QE2
is not about saving the banks. It's about funding the federal deficit
without increasing the interest tab, something that may be necessary in this
gridlocked political climate just to keep the government functioning.
On November 15, the Wall Street Journal published an
open letter to Fed
Chairman Ben Bernanke from 23 noted economists, professors and fund
managers, urging him to abandon his new "quantitative easing" policy called
The letter said:
We believe the Federal Reserve's large-scale asset purchase plan (so-called
"quantitative easing") should be reconsidered and discontinued...
planned asset purchases risk currency debasement and inflation, and we do
not think they will achieve the Fed's objective of promoting employment.
The Pragmatic Capitalist (Cullen Roche) remarked:
Many of the people on this list have been warning about bond vigilantes
while also comparing the USA to Greece for several years now. Of course,
they've been terribly wrong and it is entirely due to the fact that they do
not understand how the US monetary system works...
What's unfortunate is
that these are many of our best minds. These are the people driving the
The deficit hawks say
QE is massively inflationary
that it is responsible
for soaring commodity prices here and abroad
that QE2 won't work any better
than an earlier scheme called QE1, which was less about stimulating the
economy than about saving the banks
that QE has caused the devaluation of
the dollar, which is hurting foreign currencies and driving up
None of these contentions is true, as will be shown.
They arise from a
failure either to understand
modern monetary mechanics (see links at
Pragmatic Capitalist and
here) or to understand QE2, which is a different
animal from QE1.
QE2 is not about saving the banks, or devaluing the dollar,
or saving the housing market.
It is about saving the government from having
to raise taxes or cut programs, and saving Americans from the austerity
measures crippling the Irish and the Greeks; and for that, it may well be
the most effective tool currently available. QE2 promotes employment by
keeping the government in business.
The government can then work on adding
The Looming Threat of a Crippling Debt Service
The federal debt has increased by
more than 50% since 2006, due to a
collapsed economy and the highly controversial decision to bail out the
By the end of 2009, the debt was up to $12.3 trillion; but the
interest paid on it ($383 billion) was actually less than in 2006 ($406
billion), because interest rates had been pushed to extremely low levels.
Interest now eats up nearly half the government's income tax receipts, which
are estimated at $899 billion for
Of this, $414 billion will go to
interest on the federal debt. If interest rates were to rise
just a couple
of percentage points, servicing the federal debt would consume over 100% of
current income tax receipts, and taxes might have to be doubled.
As for the surging commodity and currency prices abroad, they are not the
result of QE. They are largely the result of the U.S. dollar carry trade,
which is the result of pressure to keep interest rates artificially low.
Banks that can borrow at the very low fed funds rate (now 0.2%) can turn
around and speculate abroad, reaping much higher returns.
Interest rates cannot be raised again to reasonable levels until the cost of
servicing the federal debt is reduced; and today that can be done most
expeditiously through QE2 - "monetizing" the debt through the Federal
Reserve, essentially interest-free.
Alone among the government's creditors,
FED rebates the interest to the government after deducting its costs. In
2008, the Fed reported that it
rebated 85% of its profits to the government.
The interest rate on the 10-year government bonds the Fed is planning to buy
is now 2.66%.
Fifteen percent of 2.66% is the equivalent of a 0.4% interest
rate, the best deal in town on long-term bonds.
A Reluctant Fed Steps Up to the Plate
The FED was strong-armed into rebating its profits to the government in the
1960s, when Wright Patman, Chairman of the House Banking and Currency
Committee, pushed to have the Fed nationalized.
According to Congressman
Jerry Voorhis in
The Strange Case of Richard Milhous Nixon (1973):
As a direct result of logical and relentless agitation by members of
Congress, led by Congressman Wright Patman as well as by other competent
monetary experts, the Federal Reserve began to pay to the U.S. Treasury a
considerable part of its earnings from interest on government securities.
This was done without public notice and few people, even today, know that it
is being done.
It was done, quite obviously, as acknowledgment that the
Federal Reserve Banks were acting on the one hand as a national bank of
issue, creating the nation's money, but on the other hand charging the
nation interest on its own credit - which no true national bank of issue
could conceivably, or with any show of justice, dare to do.
Voorhis went on,
"But this is only part of the story. And the
less discouraging part, at that. For where the commercial banks are
concerned, there is no such repayment of the people's money."
Commercial banks do not
rebate the interest, said Voorhis, although they also,
"'buy' the bonds with newly created demand
deposit entries on their books - nothing more."
After the 1960s, the policy was to fund government bonds through commercial
banks (which could collect interest) rather than through the central bank
(which could not).
This was true
not just in the U.S. but in other
countries, after a quadrupling of oil prices combined with abandonment of
the gold standard produced "stagflation" that was erroneously blamed on
governments "printing money."
Consistent with that longstanding policy, Chairman Bernanke initially
resisted funding the federal deficit.
In January 2010, he admonished
"We're not going to monetize the debt. It is very, very important for
Congress and administration to come to some kind of program, some kind of
plan that will credibly show how the United States government is going to
bring itself back to a sustainable position."
His concern, according to
The Washington Times, was that,
"the impasse in Congress over tough spending
cuts and tax increases needed to bring down deficits will eventually
force the Fed to accommodate deficits by printing money and buying
That impasse crystallized on November 3, 2010, when Republicans swept the
House. There would be no raising of taxes on the rich, and the gridlock in
Congress meant there would be no budget cuts either.
Compounding the problem
was that over the last six months,
China has stopped buying U.S. debt,
reducing inflows by about $50 billion per month.
QE2 Is Not QE1
In QE1, the Fed bought $1.2 trillion in toxic mortgage-backed securities off
the books of the banks.
QE1 mirrored TARP, the government's Troubled Asset
Relief Program, except that TARP was funded by the government with $700
billion in taxpayer money. QE1 was funded by the Federal Reserve
computer keystrokes, simply by crediting the banks' reserve accounts at the
Pundits were predicting that QE2 would be more of the same, but it turned
out to be something quite different.
Immediately after the election, Bernanke announced that the Fed would be using its power to purchase assets
to buy federal securities on the secondary market - from banks, bond
investors and hedge funds. (In the EU, the European Central Bank began a
similar policy when it bought Greek bonds on the secondary market.)
dealers would then be likely to use the money to buy more Treasuries,
increasing overall Treasury sales.
The bankers who applauded QE1 were generally critical of QE2, probably
because they would get nothing out of it. They would have to give up their
interest-bearing bonds for additional cash reserves, something they already
have more of than they can use.
Unlike QE1, QE2 was designed, not to help
the banks, but to relieve the pressure on the federal budget.
Bernanke said the Fed would buy $600 billion in long-term government bonds
at the rate of $75 billion per month, filling the hole left by China. An
estimated $275 billion would also be rolled over into Treasuries from the
mortgage-backed securities the Fed bought during QE1, which are now reaching
maturity. More QE was possible, he said, if unemployment stayed high and
inflation stayed low (measured by the core Consumer Price Index).
Addison Wiggin noted in his November 4
Five Minute Forecast that this
essentially meant the Fed planned to monetize the whole deficit for the next
He quoted Agora Financial's Bill Bonner:
"If this were Greece or Ireland, the
government would be forced to cut back. With quantitative easing ready,
there is no need to face the music."
That was meant as a criticism, but you could also see it as a very good
deal. Why pay interest to foreign central banks when you can get the money
nearly interest-free from your own central bank?
In eight months, the Fed
will own more Treasuries than
China and Japan combined, making it the
largest holder of government securities outside the government itself.
The Overrated Hazard of Inflation
The objection of the deficit hawks, of course, is that this will be
massively inflationary, diluting the value of the dollar; but a
at the data indicates that these fears are unfounded.
Adding money to the money supply is obviously not hazardous when the money
supply is shrinking, and it is shrinking now. Financial commentator
Hugh Smith estimates that the economy faces $15 trillion in writedowns in
collateral and credit, based on projections from the latest
Fed Flow of
The Fed's $2 trillion in new credit/liquidity is therefore
insufficient to trigger either inflation or another speculative bubble.
In any case, Chairman Bernanke
maintains that QE involves no printing of new
money. It is just an asset swap on the balance sheets of the bondholders.
The bondholders are no richer than before and have no more money to spend
Warren Mosler explains that the bondholders hold the bonds in
accounts at the Fed.
"U.S. Treasury securities are accounted much
like savings accounts at a normal commercial bank."
They pay interest and
are considered part of the federal debt.
When the debt is "paid" by
repurchasing the bonds, all that happens is that the sums are moved from the
bondholder's savings account into its checking account at the Fed, where the
entries are no longer considered part of the national debt.
difference is that one account bears interest and the other doesn't.
What About the Inflation in Commodities?
Despite surging commodity prices, the overall inflation rate remains very
low, because housing has to be factored in.
The housing market is recovering
in some areas, but housing prices overall have dropped 28% from their peak.
Main Street hasn't been flooded with money; the money has just shifted
around. Businesses are still having trouble getting reasonable loans, and so
are prospective homeowners.
As for the obvious price inflation in commodities - notably gold, silver,
oil and food - what is driving these prices up cannot be an inflated U.S.
money supply, since the money supply is actually shrinking.
Rather, it is a
combination of factors including,
heavy competition for these scarce
goods from developing countries, whose economies are growing much faster
the flight of "hot money" from the real estate market, which
has nowhere else to go
in the case of soaring food prices, disastrous
speculation, which is fanning the
Feeding it all are the extremely low interest rates maintained by the Fed,
allowing banks and their investor clients to borrow very cheaply and invest
where they can get a much better return than on risky domestic loans.
carry trade will continue until something is done about the interest tab on
the federal debt.
The ideal alternative would be for a transparent and accountable government
to issue the money it needs outright, a function the Constitution reserves
to Congress; but an interest-free loan from the Federal Reserve rolled over
indefinitely is the next best thing.
A Bold Precedent
QE2 is not a "helicopter drop" of money on the banks or on Main Street.
is the Fed funding the government virtually interest-free, allowing the
government to do what it needs to do without driving up the interest bill on
the federal debt - an interest bill that need not have existed in the first
As Thomas Edison said,
"If our nation can issue a dollar bond, it
can issue a dollar bill. The element that makes the bond good, makes the
bill good, also."
The Fed failed to revive the economy with QE1, but it could redeem itself
with QE2, a bold precedent that might inspire other countries to break the
chains of debt peonage in the same way.
QE2 is the functional equivalent of
what many countries did very successfully before the 1970s, when they funded
their governments with interest-free loans from their own central banks.
Countries everywhere are now suffering from debt deflation.
They could all
use a good dose of their own interest-free national credit, beginning with
Ireland and Greece.